Randall Jones
OECD Economic Surveys: Malaysia 2024
Abstract
Low productivity in micro, small and medium-sized enterprises (MSMEs) is a headwind to Malaysia’s march toward high-income status. Fulfilling the government’s goal of making MSMEs a driver of growth is crucial to slow or reverse Malaysia’s productivity slowdown in recent decades. Cross-country evidence demonstrates that the scaling up of MSMEs is a crucial element to achieve higher productivity. This is particularly true in Malaysia, where three-quarters of MSMEs have fewer than five workers. Malaysia has hundreds of programmes to support MSMEs, many targeted based on firms’ sector, location or ownership. The priority should be to create framework conditions that enable a wide range of firms to prepare for high-growth episodes. Key characteristics of firms that are able to scale up include a focus on innovation and digital technologies, access to funding to make the necessary investment, and international linkages through trade and investment. Government policies should align in critical areas such as digitalisation, finance, international trade and regulation to enable potential high-growth firms to acquire the necessary attributes. In addition, it is crucial to address the strong presence of state-owned enterprises that can limit the scope for MSMEs to scale up.
Sustained rapid and inclusive economic growth for half a century has brought Malaysia close to the threshold of high-income status. The shift from a focus on agriculture and commodity exports to a more diversified economy closely integrated into the global economy has driven the transformation. Per capita income rose from around one-third of the World Bank’s threshold for high-income countries in 1989 to 91% in 2022 (Figure 4.1). The World Bank has projected that Malaysia will achieve high-income status by 2028 (World Bank, 2021[1]).
Note: The World Bank defines high-income countries based on gross national income per capita converted into US dollars using the Atlas method.
Source: World Bank, GNI, Atlas method (current US$) | Data (worldbank.org), accessed 4 March 2024.
However, slowing productivity growth over the past three decades has raised concerns. The Twelfth Malaysia Plan (2021-25) states that the country’s productivity growth is lagging behind its neighbours due to uncompetitive business practices, restricted market access, slow reaction to new trends, and uneven industrial development. Micro, small and medium-sized enterprises (MSMEs) (Box 4.1) have an essential role to play as engines of innovation, job creation, output growth and social cohesion. The Plan notes that “MSMEs continue to be uncompetitive” as they struggle with low-value activities, insufficient funding, and ineffective resource management. Their reliance on low-skilled labour and slow progress in digitalisation and innovation has resulted in low productivity growth (Ministry of Economy, 2021[2]).
MSME productivity remains low despite hundreds of government programmes and high levels of support. The Twelfth Malaysia Plan attributed ineffective policy implementation and governance to “regulations and programmes administered by multiple agencies, resulting in an overlapping of roles and functions as well as target groups”. Looking ahead, the Plan sets an objective of making MSMEs “the new driver of growth” by: i) diffusing technology and digitalisation throughout this sector; ii) shifting MSMEs from domestic to global markets; and iii) enhancing the capabilities of Bumiputera (ethnic Malays and other indigenous peoples) entrepreneurs (Ministry of Economy, 2021[2]).
MSMEs accounted for 97.4% of Malaysia’s firms (Figure 4.2, Panel A), 38.4% of GDP and nearly half of employment in 2022. The MSME sector is somewhat smaller than the OECD average of 99% of firms, 60% of employment and 50-60% of GDP (Koirala, 2019[3]). However, there are no data on the number of workers by firm size in Malaysia. Nearly 85% of MSMEs were in the service sector, accounting for almost two-thirds of MSME output (Figure 4.2, Panel B) and employment. MSMEs account for around half of output in the agriculture and construction sectors, with smaller shares in services and manufacturing (Figure 4.3).
Note: In 2022. Micro enterprises are defined as those that have less than 5 employees or annual sales of less than MYR 300 000. In services and other sectors: small enterprises have 5 to less than 30 workers or sales of MYR 300 000 to 3 million and medium enterprises have 30 to 75 workers or sales of MYR 3 million to 20 million. In manufacturing, small companies have 5 to 75 workers or sales of MYR 300 000 to 15 million and medium companies have 75 to 200 workers or sales of MYR 15 million to 50 million. Government-linked companies (GLCs) and subsidiaries of multinational companies cannot be classified as MSMEs no matter their size. Excludes import duties.
Source: SME Corporation Malaysia, SME Corp Profile of MSMEs in 2016-2022.
MSMEs’ employment and value-added as a share of the total in each sector in 2022
Source: Department of Statistics Malaysia (2023), Micro, Small & Medium Enterprises Report 2022.
Government policies for micro, small and medium-sized enterprises
Government spending on programmes to assist MSMEs in Malaysia was relatively high at almost 1% of GDP in 2018 and 0.6% in 2019, compared to 0.15% in the Philippines and 0.4% in Czechia (Kuriakose and Tiew, 2022[4]). The government aims to increase the MSME share of GDP from 38.4% in 2022 to 50% in 2030 (Box 4.2). The outlays are disbursed through 275 different programmes that support MSMEs and entrepreneurship. The programmes are implemented by 80 different ministries and agencies, with the SME Corp. coordinating MSME and entrepreneurship policies and evaluating their impact at the national level through the SME Integrated Plan of Action.
Five major programmes account for 80% of spending. Many of the other 270 smaller programmes have similar, generic objectives. The large number of programmes and agencies administering them leads to a high degree of fragmentation and overlap, decreasing the efficacy of government efforts. The government has recognised the overlap of functions and roles in coordinating the development of the entrepreneur ecosystem and MSMEs and decided to create a permanent secretariat for the National Entrepreneur and SME Development Council (NESDC) to improve coordination. In addition, the government will create a comprehensive database containing information about MSMEs.
The Mid-Term Review of the Twelfth Malaysia Plan also noted a “lack of coordination and monitoring of initiatives and programmes” for MSMEs. Policies should not be designed in isolation but instead requires a holistic approach to policymaking. The interconnectedness of such policies that cut across ministries, departments, agencies and levels of government also requires more insights on effective whole-of-government approaches and vertical and horizontal coordination mechanisms (OECD, 2022[5]).
Programmes providing financial assistance accounted for 88.2% of government outlays for MSMEs over 2016-19. “Soft mechanisms”, such as business advice, education and training initiatives, play only a small role. Government loans and credit account for 58% of public financial support for MSMEs, followed at 36% for loans and credit guarantees, under which a government agency agrees to compensate the lender in case of a default. Grants (2%) and equity (less than 1%) provide the remainder of public financial assistance. The focus on financial support suggests that “Malaysia’s general intermediate objective for SME and entrepreneurship development is largely focused on the expansion of firms”, rather than targeting specific needs and deficiencies (Kuriakose and Tiew, 2022[4]). More than 190 of the government programmes focus on the growth and expansion phases of MSMEs, accounting for 87% of government spending on MSMEs. The remaining 80 programmes aim to help start-ups and facilitate the creation of new firms.
In many countries, MSME policies look through a narrow lens to identify and foster young firms in high-tech sectors. Unfortunately, such a “picking winners” approach aimed at identifying future unicorns has often been unsuccessful. This is even more likely in the absence of carefully designed evaluations of MSME policies that allow course corrections, when necessary, on the basis of evaluation findings. It is crucial to compare the performance of supported firms against a suitable control group that does not receive support. Ex ante monitoring and ex post evaluation should be performed regularly based on clearly defined, rigorous and measurable policy objectives and impacts (G20/OECD, 2015[6]).
The SME Masterplan 2012-20 set ambitious targets for MSMEs’ share of GDP, employment and exports (Table 4.1). Other objectives included: i) increasing firm creation at a 6% annual rate; ii) expanding the number of high growth and innovative firms by 10% annually; iii) doubling labour productivity; and iv) accelerating the formalisation of firms (National SME Development Council, 2012[7]). Despite the considerable investment in MSMEs, their share of employment and exports declined over 2010-20 and their share of GDP fell short of the target.
1. MSMEs achieved their employment target for 2020 by 2016. However, the calculation of MSME employment for 2020 and beyond was changed by including the government, the informal sector (excluding agriculture), unregistered firms in agriculture, and outsourcing activities in computing total employment, which is the denominator in calculating MSMEs’ share of employment. 2. The GCI refers to the Global Competitiveness Index. 3. The GII is the Global Innovation Index. The ranking of 36 was for 2019.
Source: National SME Development Council (2012), SME masterplan 2012- 2020; and Ministry of Entrepreneur and Cooperatives Development (2024), Pelan Strategik Perusahaan Mikro, Kecil dan Sederhana 2030 (Micro, Small and Medium-sized Enterprises Strategic Plan 2030).
Current policies set ambitious targets for 2030, based on the 2019 National Entrepreneurship Policy 2030. In addition to significant increases in MSMEs’ share of GDP, employment and exports, labour productivity is to increase by nearly one-third. The government also set a goal of having at least five home-grown or foreign unicorn start-ups in key digital industry clusters headquartered in Malaysia by 2030.
The MSME Strategic Plan 2030 lays out three main catalysts with eight focus areas (Table 4.2), 13 strategies and 56 initiatives. The Plan emphasises many of the priorities discussed in this chapter, including innovation, digitalisation, human capital, exports and regulatory reform, but it also has a specific the focus on entrepreneurs from certain groups, notably the Bumiputera.
Source: Ministry of Entrepreneur and Cooperatives Development (2024), Pelan Strategik Perusahaan Mikro, Kecil dan Sederhana 2030, (Micro, Small and Medium-sized Enterprises Strategic Plan 2030).
This chapter starts by examining the slowdown in productivity growth during the past few decades and its link to the MSME sector. The third section discusses the benefits of scaling up MSMEs to enhance productivity and economic growth and the factors that determine which firms are likely to grow. Expanding the scale of MSMEs is essential, given that more than three-quarters have less than five employees. This section also identifies characteristics of MSMEs that are able to scale up through high-growth episodes. One of the most important is the utilisation of digital tools and other new technology, which is discussed in the fourth section, along with the need for skilled workers to implement new technology. The fifth section discusses the problem of securing financing and other factors that limit scaling up. In Malaysia, MSMEs are nearly entirely dependent on their own resources and bank lending. New ways to provide equity financing, which is better suited to young firms, are a priority. This section also looks at the issues of regulation and MSME participation in international trade and global value chains. The final section looks at the large role of state-owned enterprises and government-linked investment companies, which can hinder the scaling up of small firms. The chapter concludes with recommendations to make MSMEs a key driver of growth.
Boosting productivity is the key to avoiding the “middle-income trap”. Indeed, productivity accounts for half of the gap in income per capita between high-income and developing countries (Grover Goswami, Medvedev and Olafsen, 2019[8]). Malaysia’s productivity level is significantly above that in most other ASEAN countries, as well as China and India (Figure 4.4, Panel A), though labour productivity growth has decelerated over the past 25 years as the level converged toward high-income countries (Figure 4.4, Panel B). Indeed, it slowed from an annual rate of 3.5% in the 1990s to 2.3% from 2010-21 (Figure 4.5). Malaysia’s source of economic growth will need to shift from factor accumulation, which has driven growth in recent decades, to productivity gains. Identifying policies to raise productivity is thus critical to alleviate poverty and fulfil rising aspirations. Korea, whose labour productivity level surpassed Malaysia’s in 1986, is an example of a country with sustained high productivity growth since the 1997 Asian Financial Crisis (Figure 4.4, Panel B) based on its successful post-crisis reforms.
Note: Labour productivity is defined as GDP per worker.
Source: Asian Productivity Organisation, APO Productivity database 2023, accessed 18 January 2024.
Note: Annual average growth rates. Labour productivity is defined as GDP per worker.
Source: Asian Productivity Organisation, APO Productivity database 2023, accessed 18 January 2024.
The Twelfth Malaysia Plan set a 3.6% target for annual productivity growth during 2021-25. The target was revised upward to 3.8% for 2023-25 in the 2023 Mid-Term Review of the Plan, as productivity grew at a 3.7% annual pace during the rebound from the COVID-19 pandemic in 2021-22. However, Malaysia’s trend GDP growth rate is expected to slow over the next 30 years, partly due to demographic headwinds (World Bank, 2021[1]). Achieving high productivity growth through 2025 and beyond will depend heavily on MSMEs, where productivity is around two-thirds of that in large firms (Figure 4.6, Panel A), indicating considerable scope for gains. Narrowing this gap would reduce the dual nature of the economy, with large and foreign-owned showing stronger performance and MSMEs lagging behind.
Note: Labour productivity in MSMEs in the mining & quarrying sector was slightly larger than in manufacturing in 2022 at MYR 137 000 per worker. However, labour productivity in large firms in that sector was 1 694 000, more than 12 times higher than for MSMEs.
Source: Department of Statistics Malaysia (2023), Micro, Small & Medium Enterprises Report 2022.
With MSMEs accounting for nearly half of employment, an increase in their productivity would significantly impact nation-wide productivity. The Mid-Term Review states that the productivity gap will be narrowed by MSMEs’ adoption of technology and digitalisation. However, MSMEs are highly dependent on low-skilled workers, making technological advances difficult (Ministry of Economy, 2023[9]). The large share of the labour force in low productivity MSMEs is also a driver of inequality. Although Malaysia’s Gini coefficient for disposable income fell from 45 in 1990 to 43 in 2022, it is well above the OECD average of 32.
Low MSME productivity is linked to their concentration in services (Box 4.1). On an economy-wide basis, service-sector productivity in Malaysia is only 66% of that in manufacturing, well below the OECD average of 85% (Figure 4.7). Service sector productivity is typically below manufacturing productivity, reflecting in part the inherent characteristics of services that raise transaction costs and reduce competition; i) information asymmetries between suppliers and consumers are larger for services, as their quality tends to be more difficult to assess before purchase; ii) services such as banking and mobile phone services can involve more switching costs than goods, encouraging consumers to maintain long-term relationships with their service providers; and iii) some services have to be provided in person, limiting consumer choice (Sorbe, Gal and Millot, 2018[10]).
Labour productivity in services relative to manufacturing
Source: OECD (2021), Inclusive Growth Review of Korea: Creating Opportunities for All, OECD Publishing, Paris; and Department of Statistics Malaysia, Micro, Small & Medium Enterprises (MSMEs) Performance, 2021.
The impact of low service sector productivity is currently limited by Malaysia’s relatively low share of services at 58% of GDP in 2022 compared to 70% in the OECD area (Figure 4.8). However, the headwinds from low service productivity will intensify as continued economic growth and population ageing boost the share of services to the levels in the most advanced countries.
Source: World Bank, World Development Indicators database.
The low productivity of Malaysia’s MSMEs relative to large firms (Figure 4.6) partially reflects their small size and the resulting limited opportunities to exploit economies of scale. Medium-sized enterprises account for only 1.5% of establishments in Malaysia – less than the share of large firms – suggesting a “missing middle” as most micro and small firms fail to grow. The Mid-Term Review of the Twelfth Malaysia Plan identified the inability of MSMEs to scale up as a fundamental challenge. Expanding the size of MSMEs would result in economies of scale that allow them to reduce their average unit cost of production and reach an efficient output level, leading to higher productivity and profitability. A study of six million firms in eight European countries, the United States, Canada, and New Zealand reported that countries with large shares of both fast-growing and fast-contracting firms achieve higher productivity growth. In contrast, countries with a higher share of zero-growth firms have slower productivity growth (Bravo-Biosca, Criscuolo and Menon, 2016[11]).
Among the small share of MSMEs that scale up, a few grow very quickly and account for most new jobs in OECD economies. “High-growth firms”, defined as those that grow at least 20% annually in employment or sales over three years (OECD/Eurostat, 2008[12]), accounted for only 6% of British firms but generated more than half of the jobs created over 2002-08. Newly created and slow-growing firms accounted for the remainder (Bravo-Biosca, 2010[13]). In many countries, firms that do not meet the high-growth definition destroy more jobs than they create and face declining sales. In practice, this pattern sometimes boils down to an 80/20 rule; dynamic firms that account for as much as 20% of enterprises create around 80% of new employment and sales. In addition, high-growth firms create positive spillovers in the firms that they trade with (Grover Goswami, Medvedev and Olafsen, 2019[8]). An OECD study provides more evidence on the role of firms that “scale up” (Box 4.3).
A 2021 OECD study of firm-level data in Finland, Italy, Portugal, Slovak Republic and Spain provides detailed information on “scalers”, defined as firms with 10 to 249 employees that achieve growth of at least 10% per year in employment or sales over three years. The study examined firms’ behaviour over the two years before scaling begins, three years of rapid growth and the following two years. The results for scalers were broadly consistent across the five countries. The study found that 13%-15% of SMEs scaled up their employment during 2015-17, accounting for 54% to 72% of all jobs added by non-micro SMEs (Figure 4.9). At least half of the employment scalers also qualified as high-growth firms (at least 20% annual growth). The shares of turnover scalers in employment growth were slightly larger (OECD, 2021[14]). In sum, employment and sales growth is generated by a subset of SMEs that experience high-growth episodes.
Gross job creation and destruction by young and mature scalers and other non-micro SMEs, 2015-17
Note: Firms with 10 to 249 employees that grow at least 10% per year in employment or sales over three years.
Source: OECD (2021), Understanding Firm Growth: Helping SMEs Scale Up, OECD Publishing, Paris, https://doi.org/10.1787/fc60b04c-en.
Micro firms (less than ten employees) are excluded because it would be misleading to compare their growth rates to small and medium-sized enterprises (SMEs). In OECD countries, only 3% of new firms entering the market with less than ten employees have more than ten after five years (Calvino, Criscuolo and Menon, 2015[15]). The lack of growth often reflects the entrepreneur’s objectives. Necessity-driven entrepreneurs, who are prevalent in Malaysia, usually lack other viable options for earning a living. In contrast, opportunity-driven entrepreneurs aim to create “transformative enterprises” that can achieve high growth rates. These different types of entrepreneurs have different needs and respond differently to government policies. Evidence suggests that only a negligible fraction of entrepreneurs transition from one type to the other (Ng and Stuart, 2016[16]).
In addition, a significant share of business owners have little desire to grow and innovate. For example, in over 50% of new businesses in the United States, the owners reported that non-pecuniary benefits such as “wanting flexibility over schedule” or “to be your own boss” were the primary reasons for starting a business (Hurst and Pugsley, 2011[17]).
High-growth firms are also powerful engines of employment and output growth in developing and emerging economies. A World Bank study of 11 countries found that 3.9% to 21.3% of SMEs achieved high-growth status in employment and/or sales. There is no clear relationship between the incidence of high-growth firms and a country’s per capita income. High-growth firms accounted for at least half of gross job creation in the six countries where data are available (Figure 4.10, Panel A), and accounted for more than 100% of net job creation. In Indonesia, high-growth firms recorded rapid employment growth during their high-growth episodes (Figure 4.11). Similarly, firms classified as high growth based on sales generate at least half of the total increase in sales (Figure 4.10, Panel B).
Note: High-growth firms are those that employ more than ten workers and whose employment (Panel A) or sales (Panel B) grow at an average annual rate of 20% or more over a period of three consecutive years and have positive employment or sales growth in each of the three years.
Source: Grover Goswami, A., D. Medvedev and E. Olafsen (2019), High-growth Firms: Facts, Fiction, and Policy Options for Emerging Economies, World Bank, Washington, DC.
Successfully identifying and nurturing potential high-growth firms has become a priority to boost employment, productivity and output. Indeed, the 2021 Malaysia Digital Economy Blueprint (2021-30) includes the explicit goal of having at least five home-grown or foreign unicorn start-ups in key digital industries headquartered in Malaysia by 2030.
Many countries tend to narrowly target support on firms deemed to be potential high-growth firms, typically young firms in high-tech sectors, as such support is expensive. This makes it essential to be able to identify potential high-growth firms. However, information on the characteristics of potential high-growth firms is limited. A World Bank study found that the success rate in identifying high-growth firms before or during their high-growth episodes is only 2% to 12%. It concludes that identifying potential high-growth firms and crafting policies to promote their scaling up “remains mostly art rather than science” (Grover Goswami, Medvedev and Olafsen, 2019[8]). Many countries rely on ad hoc interventions instead of building an evidence-based foundation on which to develop effective policies to nurture potential high-growth firms (Nightingale and Coad, 2013[18]).
Note: Size is defined by the number of workers employed by high-growth firms at the beginning of their growth episode (initial size) or at the end (final size). High-growth firms are enterprises that employ more than ten workers and whose employment grows at an average annual rate of 20% or more over three consecutive years.
Source: Ferro and Kuriakose, 2018. “Indonesia: High-Growth Firms.” Background paper for High-Growth Firms, World Bank, Washington, DC.
What types of firms are most likely to become scalers and high-growth firms?
Recent OECD studies suggest four stylised facts about high-growth and scaler firms:
While young firms are more likely to achieve high growth, most high-growth firms are mature enterprises. A higher share of young firms achieving high growth is found in many OECD countries (Criscuolo, Gal and Menon, 2014[19]) and emerging countries (Grover Goswami, Medvedev and Olafsen, 2019[8]). Firms less than six years old are three times more likely to scale up than those in business over 20 years. However, only around one-fifth of SMEs are young firms (less than six years old (OECD, 2021[14]), reflecting the high failure rate. Mature firms (at least six years old) account for nearly three-quarters of SMEs that scale up (Figure 4.12, Panel A) and almost four-fifths of gross job creation (Figure 4.12, Panel B).
Although firms in high-tech sectors are more likely to scale up, most scalers are in low and medium-low technology sectors (Figure 4.13). Firms in knowledge-intensive services are 70% more likely to scale up in employment than firms in low and medium-low tech manufacturing. However, only around 15% of SMEs operate in knowledge-intensive services.
Firms that scale up are not necessarily small. Firms of different sizes have similar propensities to scale up (OECD, 2021[14]). In Indonesia, nearly half of firms that scaled up employed more than 50 workers at the beginning of their high-growth episode (Grover Goswami, Medvedev and Olafsen, 2019[8]). US firm-level data shows no systematic relationship between firm size and relative growth (Haltiwanger, Jarmin and Miranda, 2010[20]).
Scaler firms are not limited to a country’s most economically-developed regions. The share of scalers in regions with a per capita income lower than the national average, such as Andalusia and Murcia in Spain and Basilicata, Campania and Puglia in Italy, are characterised by a higher incidence of scaling up than wealthier regions in the same country (OECD, 2021[14]). This is pertinent to Malaysia, given the priority on promoting development in Sabah and Sarawak.
Note: For employment scalers. Micro SMEs are excluded as comparing the relative growth of firms with less than ten workers with larger firms is misleading. Panel A shows the age of scaler firms that ended their first three-year scaling period between 2006 to 2015 in Spain, 2013 to 2014 in Portugal, 2011 and 2015 in Finland, and 2004 to 2015 in Italy. In Panel B, young scalers are less than six years old and mature scalers are six years old and above.
High-growth phases tend to be temporary, one-time events, and consecutive scaling-up phases are rare (Coad et al., 2014[21]). In the United States, only 1.2% of high-growth firms repeated a high-growth episode during the following three years (NESTA, 2009[22]). In Indonesia, a high-growth firm that has just completed a high-growth episode has a 4.7% likelihood of following it with a second episode (Table 4.3). The majority are thus “one-hit wonders”. In sum, “high-growth firms do not appear to be a type of firm, but rather a phase that some firms go through during their life cycle” (Commonwealth of Australia, 2017[23]). Most high-growth firms maintain their larger scale after the high-growth episode. In the 2021 OECD study, between 40% and 70% of employment or turnover scalers remain at their newly achieved scale or continue to grow gradually during the three years after scaling up (OECD, 2021[14]).
Share of employment-based scaler firms by main sector of activity in 2018
Note: This excludes micro SMEs (less than ten employees) as it is misleading to compare their relative growth with larger firms.
Source: OECD (2022), Financing Growth and Turning Data into Business: Helping SMEs Scale Up | en | OECD.
Note: High-growth firms have experienced at least 20% growth in employment for at least three years. The data are limited to firms with at least ten employees. Birth refers to the first year that a firm is observed.
Source: Grover Goswami, A., D. Medvedev and E. Olafsen (2019), High-Growth Firms: Facts, Fiction, and Policy Options for Emerging Economies (worldbank.org).
What factors are most likely to trigger a high-growth episode?
Understanding the factors that enable some firms to scale up is crucial to create an environment that supports the process. Scaling up usually involves an inner transformation of the firm, which may be triggered by its characteristics, such as the entrepreneurs’ skills and motivation. It can also result from external factors, such as increased demand and technological advances, and policy measures, such as regulatory reform. A 2021 OECD study finds a number of “anticipatory differences” during the two years before the high-growth period starts that are interconnected and mutually reinforcing (OECD, 2021[14]):
Innovation and digitalisation: Firms that achieve high-growth episodes have a considerably higher rate of adopting digital technologies and use more IT resources (Benedetti Fasil et al., 2021[24]). A larger skilled workforce and more R&D staff reinforces the investment in innovation (OECD, 2021[14]).
Finance: Firms that plan to grow take on more debt than firms with no growth ambition.
Investment: Studies of French and Italian firms show that investment intensity is higher in firms that will scale up in the following period (OECD, 2021[14]).
International links: A significant share of scalers are involved in international trade prior to their high-growth episodes and the share rises with stronger growth (OECD, 2021[14]). In Hungary and Mexico, a firm’s exporting status is strongly and positively correlated with a firm’s likelihood of experiencing a high-growth event (Grover Goswami, Medvedev and Olafsen, 2019[8]).
As a result of these anticipatory differences, firms that will turn into scalers or high-growth firms begin with higher productivity than their peers (OECD, 2021[14]). Building on these anticipatory differences, the gap between scalers and high-growth firms and their peers widens during the high-growth period. Labour productivity in the United States is higher for high-growth firms, and the gap widens over time, (U.S. Small Business Administration (SBA), 2008[25]). The link between a firm’s labour productivity and the likelihood of scaling up is also found in developing countries (Grover Goswami, Medvedev and Olafsen, 2019[8]).
A strategy to promote the scaling up of MSMEs
The universe of high-growth firms is more diverse than the stereotype of young start-ups in high-technology sectors. Instead, the typical scaler is a mature firm operating in less knowledge-intensive services that achieves rapid growth only once in its lifetime. Scalers can thus be found in all sectors, regions, firm sizes, and ages (OECD, 2023[26]; Grover Goswami, Medvedev and Olafsen, 2019[8]). Consequently, the focus of SME policies on high-tech sectors is misplaced.
The diversity of potential high-growth firms suggests avoiding “picking winners” or trying to identify future “gazelles” and “unicorns”. The results from venture capital show that even in the hands of professional investors, success is often random and most projects lose money (Grover Goswami, Medvedev and Olafsen, 2019[8]). Such an approach is particularly hazardous for governments, as it leads to the waste of public funds. Moreover, it carries the risks of distortions based on political influence and a culture of rent-seeking and politically-connected firms. An OECD study found that efforts to target winners resulted in a multiplication of public support schemes and eligibility criteria, leading to the waste of government funds. This makes it difficult for potential scaler firms to identify the most suitable government programmes for their growth (OECD, 2022[5]).
The government made “breaking the barriers for MSMEs to scale up” a priority in the Mid-Term Review of the Twelfth Malaysia Plan (Ministry of Economy, 2021[2]). The Review attributed the “inability of MSMEs to scale up and stay competitive” to “inadequate policies and initiatives in scaling up MSMEs”. When trying to identify potential high-growth firms, it is crucial to avoid looking through a lens that is too narrow. Policymakers should not focus support on young, high-technology firms in manufacturing, as that would exclude more mature firms operating in low-technology services, which account for most high-growth firms, as noted above. Policies should be based on the evidence that successful scaling up is achieved by a diverse group of firms during a unique phase of their lifetime rather than by a small group of exceptional firms that consistently achieve high growth. Rather than targeting potential high-growth firms, policymakers should instead focus on creating the right framework conditions and support that enable a wide range of firms seeking to grow to acquire the “anticipatory differences” found in future high-growth firms. In other words, policies should be firm-neutral but growth-episode friendly (Grover Goswami, Medvedev and Olafsen, 2019[8]).
A strategy to facilitate the scaling up of MSMEs requires a broad approach that addresses the obstacles facing firms. First, “overcoming low awareness and limited investment in digitalisation” (Ministry of Economy, 2021[2]). Second, implementing new technology requires addressing the shortages of skilled labour. Third, expanding the availability of financing is a prerequisite for scaling up. Fourth, enhancing the role of MSMEs in international trade would be a driver of growth. Fifth, regulatory reform, particularly in sectors where MSMEs are prevalent, would offer new growth opportunities. Sixth, scaling back the role of government-linked companies and government-linked investment companies would create more opportunities for MSMEs to scale up. Another concern is the availability of labour necessary to scale up, making it important to bring informal workers into the formal sector (Chapter 2).
Digitalisation is a distinctive feature of firms that scale up. This feature extends before, during and after the high-growth episode. For MSMEs, digitalisation is a game-changer by allowing them to compete on a more even footing with larger firms. It facilitates MSME scaling up by enhancing their access to markets without the need for large-scale investments in marketing and distribution. Digital platforms leverage network externalities, data, and disruptive technologies, leading to greater efficiency, higher productivity and increased consumer welfare (OECD, 2022[5]). Moreover, digitalisation helps overcome labour shortages. Digital gaps at the firm level are strongly associated with differences in scaling up, productivity, innovation and growth. In Malaysia, increased use of computers and the Internet and greater participation in e-commerce are correlated with the growth and level of service-sector productivity for all firm sizes (Figure 4.14).
Labour productivity in the service sector, in log of MYR per worker in 2015
Note: Micro firms in the service sector are defined as having less than five workers and SMEs as having between five and 75 workers. The three groups of digital uptake are not mutually exclusive. For example, computer-using firms could include firms using the Internet or participating in e-commerce.
Malaysia performs well in global indices measuring digital competitiveness. For example, the 2023 IMD World Digital Competitiveness Ranking measures the capacity and readiness of 64 economies to adopt and explore digital technologies as a critical driver for economic transformation. Malaysia was ranked 33rd, above its ASEAN peers, India and 12 OECD member countries, and was on par with Japan (Figure 4.15). However, Malaysia lags significantly behind high-income economies in the East Asia Pacific region, where it ranks sixth in the number of digital businesses relative to GDP. Nearly one-third of digital businesses operating in Malaysia are headquartered overseas in 39 countries, with the largest shares in Singapore, the United States, the United Kingdom and India. Foreign enterprises are better funded: the average total funding received by foreign e-commerce firms in Malaysia is more than five times higher than domestic firms (Kuriakose et al., 2022[27]).
Note: The rankings are based on a mixture of hard data and survey replies from business and government executives on a country’s knowledge, technology and future readiness for digitalisation.
The upward trend in the share of the information and communication technology (ICT) sector in Malaysia’s GDP increased during the pandemic (Figure 4.16, Panel A). E-commerce made the largest contribution to the upward trend, rising at a double-digit pace during 2021-22 due to new users of digital tools during the pandemic before slowing to only 1% during the first three quarters of 2023 (Department of Statistics Malaysia (DOSM), 2023[28]). The Twelfth Malaysia Plan set a target of 25.5% of GDP in 2025 for the ICT sector, driven by the adoption of digitalisation in healthcare, oil and gas, and tourism. ICT industry accounted for about 8% of the labour force and Malaysia’s net exports of ICT goods amounted to 8.6% of GDP in 2021. Progress in digitalisation is also visible in the rising share of firms using computers and the Internet and having a web presence (Figure 4.16, Panel B). By 2021, more than 90% of firms used both computers and the Internet. The share with a web presence remained relatively low and varied from 49% in agriculture to 72% in manufacturing.
Note: The ICT sector includes ICT industry (manufacturing, trade and services) and ICT content and media. E-commerce is a medium or platform for buying or selling goods and services online.
Source: Department of Statistics Malaysia (2023), digitaleconomy_2022.pdf (dosm.gov.my).
Small firms lag behind in digitalisation
To make digitalisation a major driver of the Malaysian economy, it is crucial to narrow the gap between the companies that have implemented digital technologies, which tend to be large firms, and MSMEs, most of which have yet to fully embrace digital opportunities (World Bank, 2018[29]). In particular, the cost of digitalisation is a burden to MSMEs. MSME use of digital tools in 2017 was lowest in the service sector, reflecting low take-up in food and beverages, transport and storage (Kuriakose et al., 2022[27]). As noted in the 2021 OECD Economic Survey of Malaysia, “A number of SMEs, especially micro-sized firms, do not use computers and the Internet. Most SMEs do not make their transactions through e-commerce” (OECD, 2021[30]).
The COVID-19 pandemic has accelerated digitalisation worldwide, making it a silver lining of the crisis. Increased demand for online services and goods during the crisis opened up opportunities for existing firms to scale up and new entrepreneurs to enter the market. Firms mitigated the impact of the pandemic by turning to digital technologies, notably by reaching customers and selling on digital platforms. Business surveys suggest that up to 70% of MSMEs worldwide have intensified their use of digital technologies due to the pandemic. As in other countries, Malaysian firms’ use of digitalisation to cope with the crisis was correlated with their size – the smaller the firm, the less likely it was to adopt new digital tools (OECD, 2021[31]). Around 83% of large firms responded to the COVID-19 crisis by investing in digital solutions compared to 54% of small firms, reflecting their limited capacity for investment in new technology (Figure 4.17, Panel A). Moreover, the value of firms’ digital investment relative to their sales also increased with the size of firms; large firms invested on average five times more relative to their sales revenues than small ones during the pandemic (Figure 4.17, Panel B). Firms that invested in new digital solutions to cope with the pandemic had only a 10% decline in sales compared to 22% for firms that did not invest (controlling for size, sector, and region) (World Bank, 2023[32]).
MSME digitalisation has remained limited, focusing on basic services and customer-facing business (“front end”) functions, such as marketing and social media presence. In contrast, large firms invest more in digital solutions covering broader business activities, including more advanced “back end” functions, such as administration, accounting, production and supply chain management (Kuriakose and Tiew, 2022[4]). Only 54% of MSMEs use back-end processes, which would allow them to rethink their business strategies. This situation is sometimes called a “computerisation trap” (SME Corp. and Huawei, 2018[33]). Consequently, digitalisation was more likely to fundamentally change the operations of large firms.
Note: During 2020-22. The change in sales is controlled for the size, sector and region of firms.
Source: World Bank (2023) Malaysia Economic Monitor February 2023: Expanding Malaysia's Digital Frontier (worldbank.org).
The Twelfth Malaysia Plan stated that MSMEs’ “reliance on low-skilled labour and their slow progress toward automation and mechanisation resulted in low productivity growth”. To make MSMEs the new driver of growth, the Plan set an objective of accelerating their development through technology and digital adoption (Ministry of Economy, 2021[2]) with a focus on back-end operations to transform the conventional way of doing business (Minister of Investment, Trade and Industry, 2023[34]). The Plan set a target of digitalising 90% of SME business operations. The government will also introduce “a prerequisite digital adoption requirement for businesses” to strengthen existing campaigns for society to go cashless (Ministry of Economy, 2021[2]). To achieve this goal, the central bank has been promoting the use of e-Payment by small merchants. In other countries, including Korea, such measures improved tax compliance by small companies (OECD, 2003[35]). Digitalisation is also a priority in the public sector. In 2022, the government launched a digital literacy programme for civil servants to improve the delivery of public services (Ministry of Economy, 2021[2]).
Creating a more favourable digital economy ecosystem
The Mid-Term Review of the Twelfth Malaysia Plan identified the country’s unfavourable digital economy ecosystem as a key obstacle to promoting digitalisation. It suggested areas for improvement, which are crucial to digitalisation:
Enhancing digital governance
Building a conducive digital infrastructure
Bridging the digital divide
Improving government policies for digitalisation
The priority is to streamline the roles and functions of ministries and agencies. The Malaysian government is among the most active in Asia in supporting the digitalisation of MSMEs. Over a dozen public strategies have focused on this area during the past decade, of which the 2021 Malaysia Digital Economy Blueprint (2021-30) is the most important (Prime Minister’s Department, 2021[36]). Around 25 central government ministries and agencies and at least ten state and municipal agencies offer more than 100 programmes to promote the digitalisation of MSMEs. The government’s response to the pandemic increased the number of programmes. More than 40% of programmes provide some form of financial support; grants (33%), soft loans (7%), equity (2%) and guarantees (1%), with a maximum benefit of MYR 20 million (USD 4.8 million). In addition, 80% of the programmes deliver non-financial support, notably training on digital technologies and managerial training.
When multiple programmes and agencies perform similar functions and target the same beneficiaries, it can result in wasted resources and confusion, with resources spread too thin across the programmes. For example, one study identified 29 recent initiatives in Malaysia intended to educate MSMEs regarding e-commerce opportunities, 32 providing financial support to invest in digital solutions and 40 offering training on digital technologies (Kuriakose and Tiew, 2022[4]). One reason is that many programmes are targeted at specific groups based on size (typically micro-enterprises or SMEs), ownership (Bumiputera, youth, women, or at least 50% Malaysian-owned), sector (such as manufacturing or retail), age of the firm (number of years in operation), and location (a particular state or area) (Figure 4.18). The large number of programmes could also create confusion for SMEs seeking support to adopt digital technologies. Most digitalisation programmes reach only “a very small fraction of the total number” of the 1.2 million MSMEs. One survey of MSMEs found that only about half were aware of these government programmes. Some of the MSMEs that did participate found the application process for government programmes to be overly complex, lengthy and opaque. Weaknesses include cumbersome application processes and poor user experience; long processing times, especially for the disbursement of grants; and a lack of clarity regarding grant approval/rejection and grant and programme continuity, as assistance may end when funds are exhausted (Kuriakose and Tiew, 2022[4]).
Share of programmes
Source: Kuriakose, S. et al. (2022), Digitalizing SMEs to Boost Competitiveness, World Bank Group, Washington, D.C.
A more integrated and coordinated approach within the federal government and between it and the states is needed to identify the overlaps, synergies and gaps in programmes. This would allow a better alignment of the roles and functions of ministries and agencies across the federal and state governments and promote inter-agency coordination to optimise the use of resources (Ministry of Economy, 2023[9]). A more integrated and coordinated approach depends in part on rigorous cost-benefit analysis to identify what approaches are most successful. Effectively using the MyAssist MSME Portal, an online one-stop shop with detailed information on all programmes, would improve coordination and allow MSMEs to identify the programmes that best meet their needs. Another priority is to improve the application process. Public agencies supporting MSME digitalisation should conduct and publish monitoring and evaluation of their programmes to ensure that the public resources used have significant and durable positive impacts on many firms. This requires a rigorous comparison of productivity and profitability of firms receiving assistance with a control group that does not receive support, as is done in some countries (Chang, 2016[37]).
Building a conducive digital infrastructure
In a survey of Malaysian MSMEs, 40% cited connectivity as an obstacle to digitalisation (Figure 4.19). The problem is most serious in less developed regions. The operability of cloud computing and the Internet of Things, and usage of big data technologies depend on reliable service capable of sustaining high volumes of information. Access to the Internet depends, in turn, on basic infrastructure elements, such as a reliable power supply and cable infrastructure. In Malaysia, the pandemic crisis triggered a rapid expansion in access and usage of the Internet. Although Malaysia lags in the number of fixed broadband connections per capita compared to OECD countries (Figure 4.20, Panel A), it exceeds the number of mobile subscriptions (Figure 4.20, Panel B).
Note: Based on a 2018 study of 2 033 MSMEs representing all sectors (services, manufacturing, construction and agriculture) and regions of Malaysia.
Source: SME Corp. and Huawei (2018), Accelerating Malaysian Digital SMEs: Escaping the Computerisation Trap.
While Internet usage increased sharply during the pandemic, concerns remain about the affordability and quality of Internet access. Indeed, in a 2018 survey of more than 2 000 MSMEs, the major issues regarding Internet connectivity were affordability (52%) and speed (47%). Fixed and mobile telecom prices relative to income per capita in 2022 exceeded the OECD average (Figure 4.20, Panels C and D). In the Economist Impact Index, Malaysia ranked 53rd out of 100 countries in the cost of Internet access relative to income levels, reflecting an insufficiently competitive digital environment (Economist Impact Index, n.d.[38]). The regulatory framework for prices for fixed and mobile connectivity are guided by the Mandatory Standard on Access Process. In terms of quality, the speed of Malaysia’s fixed and mobile broadband infrastructure is behind that of neighbouring countries, such as Thailand, Singapore and China (World Bank, 2023[32]). At the end of 2022, 47.1% of populated areas were covered by 5G mobile networks, which are more than twice as fast as 4G, and 96.9% were covered by 4G (JENDALA (Jalinan Digital Negara), 2023[39]). In the Economist Impact Index, Malaysia ranked 41st in the quality and breadth of available infrastructure for Internet access (Economist Impact Index, n.d.[38]).
Increased access to digital infrastructure can lead to job creation while improving consumer welfare. The Mid-Term Review of the Twelfth Malaysia Plan stated that the government will utilise government-owned land and buildings to accelerate the development of telecommunication infrastructure (Ministry of Economy, 2023[9]). To improve affordability and availability, it is essential to develop digital infrastructure by promoting competition (World Bank, 2023[32]). Competition can be enhanced by ensuring appropriate licensing and regulatory rules, constraining anti-competitive behaviour and reducing costs for operators. In particular, Malaysia should amend the Competition Act 2010 to enable authorities to identify and address potential threats before a merger, rather than trying to correct anti-competitive outcomes afterwards. In addition, the authorities will have to cope with the emergence of digital platforms that allow the exploitation of network effects (World Bank, 2023[32]).
In 2022
Note: The fixed telecom price refers to a fixed-broadband basket with 5 GB and the mobile telecom price refers to a high-usage voice and data plan allowing up to 140 minutes of phone calls, 70 SMS and 2 GB data using at least 3G technology.
Source: International Telecommunication Union; and OECD calculations.
In addition, trade restrictions on two areas crucial to the digital economy – telecommunications and computer services – are relatively high in Malaysia (Figure 4.21). Easing foreign entry restrictions in telecommunications would help boost investment in modern, high-quality, and affordable telecommunication services, closing significant gaps in Malaysia’s digital infrastructure. In particular, it would improve the speed and quality of telecommunications services, primarily through fixed fibre broadband and in next generation communication networks to keep pace with advancements in digital technology (World Bank, 2023[32]). Such progress would help Malaysia’s MSMEs expand their business across international borders (OECD, 2021[30]). The high restrictions on computer services (Figure 4.21, Panel B) limit cross-border data flows. Foreign firms must incorporate or register a branch in Malaysia to provide computer and other digitally-enabled services. The 12-month limit on the period of stay for foreign specialists has restricted the movement of skilled labour. Given the shortage of skilled workers in Malaysian MSMEs, further reducing these barriers would foster their digitalisation.
0 (open) to 1 (closed)
Source: OECD Stat., Services Trade Restrictiveness Index, accessed 23 February 2024.
Bridging the digital divide
The slower pace and depth of digitalisation in the MSME sector are widening the digital divide in Malaysia. In addition to the negative impact on productivity and growth, the digital divide aggravates income inequality (OECD, 2021[31]). First-mover advantages in digital markets and strong network effects can exacerbate the digital divide. Moreover, there are complementarities in digital diffusion: the adoption of technology A rises with the adoption of technology B. The digital divide in Malaysia is reflected in significant regional differences in the use of digital tools. The share of firms without a web presence was over half in seven of the 16 states and territories (Figure 4.22). In particular, MSMEs operating in rural areas and in East Malaysia (Sabah and Sarawak) face inadequate digital infrastructure and connectivity (Kuriakose et al., 2022[27]).
The government’s goal is “affordable, quality, safe and secure access to digital technologies and services, including connectivity, for everyone to better lives” (Ministry of Economy, 2023[9]). It is implementing a national digital infrastructure plan (Jalinan Digital Negara (JENDALA)) and developing the Malaysia Digital Inclusiveness Index to measure the digital divide and enable targeted policies, including resource allocation and talent development. Earmarked programmes, such as the National Information Dissemination Centre (Nadi), are essential to boost digital literacy and enhance trust to achieve wider digital adoption, particularly among vulnerable groups. Such programmes should address the digital divide and prepare MSME employees for the changing work environment brought about by the digital transformation.
Share of firms in each state
Source: Department of Statistics Malaysia (2023), Malaysia Digital Economy 2023.
Upgrading technology and human skills
The second and third most serious obstacles to the uptake of digitalisation by Malaysia’s MSMEs are weaknesses in the employee skill set and a lack of the necessary technology (Figure 4.19). Compared to their ASEAN peers, Malaysian MSMEs are less likely to adopt complex innovations and technologies in their business operations and management practices due to a lack of technical capabilities (Kuriakose and Tiew, 2022[4]). The 2023 Productivity Report identifies “sluggish technology adoption, especially among small and medium enterprises” as the key obstacle to improving productivity (Malaysia Productivity Corporation, 2023[40]). Progress in digitalisation would be an effective catalyst for further innovation, as it reduces transaction costs through better and quicker access to information and communication between staff, networks and suppliers. Moreover, it facilitates access to resources, training, finance and recruitment channels and enables firms to generate data and analyse their operations in new ways (OECD, 2021[31]).
Malaysia’s total R&D expenditure grew from 0.2% of GDP in 1996 to a peak of 1.4% in 2016. However, it gradually declined to around 1% of GDP in 2020, as R&D expenditure by the business sector fell by more than half, and remained around 1% in 2021 (Figure 4.23, Panel A). Malaysia ranks low relative to OECD countries in R&D spending (Figure 4.23, Panel B). In addition, the number of researchers (per 10 000 in the labour force) fell from 74 in 2016 to 33 in 2020 (Ministry of Science, Technology and Innovation, 2023[41]).
Low levels of R&D spending, research staff and patenting contribute to Malaysia’s score behind China and the average of five neighbouring countries in the World Intellectual Property Organization’s (WIPO) 2023 Innovation Index scores for creative outputs and knowledge and technical outputs (Figure 4.24). Malaysia does rank above ASEAN peers, except Singapore, in its overall ranking, suggesting large potential for innovation.
The Twelfth Malaysia Plan set target for total R&D expenditure of 2.5% of GDP by 2025. To help achieve the target, the government will encourage increased access to alternative financing, including through venture capital and international funding. In addition, an endowment fund will be established to source funds from industry, matching grants, crowdfunding and charitable contributions for R&D activities related to science and technology (Ministry of Economy, 2021[2]). It is essential that the newly formed Research Management Unit (RMU), under the Economic Planning Unit, ensure that public R&D funds are used effectively.
Source: Ministry of Science, Technology and Innovation (2023), Summary Report National Survey of Research and Development (R&D) in Malaysia 2021 | Malaysian Science and Technology Information Centre (mosti.gov.my).
Only 6% of small firms and 20% of medium-sized firms invest in R&D, which is low compared to Viet Nam, the Philippines and China (Figure 4.25). MSMEs’ R&D activities are limited by insufficient skills and funding, making it difficult to expand their in-house innovation capabilities. Given these weaknesses, it is essential to increase MSMEs’ uptake of R&D by strengthening their collaboration with experts in academia and the business sector to benefit from knowledge spillovers from other firms and universities. However, programmes and instruments targeting R&D by MSMEs account for a relatively small proportion of government support for MSMEs (Kuriakose and Tiew, 2022[4]). Companies that engage in research can apply for “R&D status”, which allows them a double tax deduction for R&D expenditures. Such incentives are less effective for young MSMEs, as they are typically not profitable in their early years. Making R&D tax incentives more advantageous for small firms and increasing their access to new technology by focusing government research institutes’ R&D on issues pertinent to MSMEs would promote greater innovation in MSMEs. Some OECD countries use refundable R&D tax credits to promote innovation by MSMEs (Box 4.4).
Note: The ASEAN-5 consists of Indonesia, Philippines, Singapore, Thailand and Viet Nam.
Source: Kuriakose, S. and H. Tiew (2022), Malaysia: SME Program Efficiency Review.
In 2022, 33 OECD countries offered tax incentives to firms that invest in R&D. Of these countries, 21 offered refundable (payable) tax credits or equivalent incentives. Tax credits directly reduce the amount of tax a firm owes, in contrast to tax deductions, which reduce a firm’s taxable income. A refundable tax credit provides a refund even if the tax owed is zero. Three of the OECD countries offering refundable tax credits – Australia, Canada and France – explicitly target SMEs and young firms with preferential treatment relative to large enterprises (OECD, 2023[42]).
France introduced the Credit d'Impôt Innovation (CII) or Research Tax Credit in 2013. It allows SMEs to receive tax credits on expenses related to developing prototypes or pilot trials of new products. The tax credit rate is 20% and expenses subject to the tax credit are capped at EUR 400 000 per year, with any unused amount of credit allowed to be carried over for up to three years. Eligible expenses include staff costs, intellectual property acquisition, and research contracts with third parties. Thanks to this generous scheme, 86% of R&D tax relief recipients in 2019 were SMEs.
The CII is particularly suited to encouraging research commercialisation by supporting prototype development. It also has less distortive effects on the market, as it covers only the development phase and not the production phase. One limitation is that innovations in the service sector and non-technological innovations, such as those in marketing and business processes, are not eligible for the tax credit (OECD, 2018[43]).
MSMEs’ shortage of skilled workers is recognised as a serious obstacle in the Mid-Term Review of the Twelfth Malaysia Plan. While the COVID-19 pandemic forced many MSMEs to introduce digital tools, they often lack the human capital to effectively use those tools. Around 58% of small firms (5-19 employees) report difficulties finding workers with computer or general IT skills. In addition, less than a quarter of small and medium-sized firms (less than 100 workers) provide formal training compared to more than 70% of large firms (Kuriakose and Tiew, 2022[4]). Firms that pay higher wages and attract better workers are more likely to become high-growth firms (Grover Goswami, Medvedev and Olafsen, 2019[8]). However, MSMEs face challenges in retaining top talent due to limited ability to pay competitive salaries and provide career development opportunities. MSMEs are thus caught in a vicious circle: low wages and productivity prevent them from attracting the skilled labour that would allow them to become high-growth firms. The government classifies 72% of workers as low-skilled or semi-skilled, leaving only 28% qualifying as skilled, and the share has increased only slightly since 2015 from 25.5%. The mean years of schooling in Malaysia is 10.6 compared to as many as 14 years in some OECD countries (United Nations Development Programme, 2022[44]). Malaysia aims to boost its mean years of schooling to 11.6 by 2026.
Malaysia’s Critical Occupations List, which identifies mid and high-skilled occupations that are experiencing labour shortages, reported that the demand for advanced digital skills has been increasing more rapidly than its supply, despite the government providing training and up-skilling programmes for basic digital skills (OECD, 2021[30]). Five of the six occupations requiring digital skills that appeared in the 2018/2019 List have remained on it for the past six years, indicating a persistent shortage of those skills. In addition, the education requirements for these job vacancies also fell, which may adversely affect productivity (World Bank, 2023). The need for greater digital education is underlined by a poll of MSMEs during the COVID-19 pandemic asking why they had not introduced digital technology. More than a quarter responded that they did not see the need, the benefits were uncertain or they lacked information (Kuriakose et al., 2022[27]).
Digital education is thus a key to unlocking the benefits of digitalisation. In Malaysia, digital education has prioritised front-end (i.e., customer-facing) business functions, such as sales and marketing, and e-commerce through participation in digital platforms. While this is in line with the needs expressed by the businesses themselves, going forward, it is necessary to increase the emphasis on back-end skills (World Bank, 2023[32]). The digital and technology “Big Bold” initiative in the Mid-Term Review of the Twelfth Malaysia Plan stated that measures to improve digital skills should be done in collaboration with the business sector (Ministry of Economy, 2023[9]). Another major obstacle to digitalisation is a lack of management skills. In a 2022 survey asking SMEs why they did not invest in digital solutions, around 30% of SMEs said that they saw “no need” and a similar share responded that the benefits were uncertain. Around a quarter said that they did not invest in digital solutions because the lacked information (World Bank, 2023[32]). Innovative approaches in Mexico and Canada offer ideas on how to overcome such obstacles (Box 4.5).
Mexico launched a so-called “tablet programme” in 2015 to assist micro-enterprises primarily in traditional sectors, such as retail trade (60% of the firms) and low value-added manufacturing. This innovative approach combines basic training in key management principles with the provision of new ICT solutions. Management training focuses on areas crucial for the survival and growth of small firms: the use of management software, inventory management, accounting, customer relationships, micro-market analysis and repayment capability. Moreover, participants receive a tablet that includes the management software, another software programme that enables customers to pay utility bills and phone charges, and a swipe-card extension to the tablet that allows customers to pay by credit/debit card. As many of these firms operate in the informal economy, another objective is to bring them into the formal economy.
The training programme had 70 000 participants during its first two years. One concern is that the training provided by organisations can lead to the exit of organisations that do not receive such support. In sum, this approach could have a positive impact in Malaysia, where enterprises with fewer than five employees account for three-quarters of firms.
The Canadian government created in 2004 the Canada Business Network (CBN), a “click, call, and visit” nationwide business service to provide information (free of charge) on starting, growing and closing a business. The website has become the major point of contact for business-related information, including on SME support programmes and services. In Fiscal Year 2012-13, the national web portal recorded 2.25 million visits. In addition, the CBN links visitors to information on government programmes and services, both at the federal and provincial levels, as well as to BizPaL, an online service for information on business permit and licensing requirements at the federal, provincial and municipal levels. For Malaysia, a partnership between central and state governments would help provided help to SMEs throughout the country.
In addition to the challenges of acquiring the necessary technology and the lack of employees with the appropriate IT skills, as discussed above, MSMEs face other obstacles to making a significant step towards upscaling and digitalisation. According to the results of the survey of MSMEs presented in Figure 4.19, these include i) financing to meet the costs of digitalisation; ii) sufficient networks, including overseas; and iii) regulations that inhibit the transformation of an enterprise. Only 10% of MSMEs said they did not need assistance to digitalise. This section will focus on the issues of financing, international trade and regulation.
Providing financing for MSMEs
The Mid-Term Review of the Twelfth Malaysia Plan stated that improving the accessibility of financing is a key to the scaling up of MSMEs (Ministry of Economy, 2023[9]). The relationship between financial development and the performance of high-growth firms in upper-middle-income countries (such as Malaysia) is significantly positive (Grover Goswami, Medvedev and Olafsen, 2019[8]). Obtaining access to financing is particularly difficult for smaller enterprises.
The rationale of public support for financing for MSMEs and the risks
Market failures justify financial support to MSMEs. Small firms’ absence of collateral, short credit history and lack of expertise needed to produce financial statements limits their access to credit. For lenders, the small scale of lending may not compensate for the cost of screening and monitoring, resulting in an information asymmetry. As a result, financial institutions attribute a high risk of default to borrowers, providing some justification for government intervention to overcome this market failure. In principle, the level of public financing support for MSMEs should depend on the financing gap, i.e., the difference between the amount of SME financing that would occur in the absence of market failures and the actual amount of financing, although this is difficult to calculate in practice (Jones and Kim, 2014[45]). In particular, closing the financing gap should enable MSMEs to build up intangible assets, such as patents, software, databases, managerial skills and distribution skills, which are key drivers of innovation and productivity growth. Financing MSMEs’ acquisition or development of intangible assets is more difficult than for tangible assets (Demmou and Franco, 2021[46]).
While government policies are needed to help overcome market failures that limit MSME financing, generous government support for SMEs has negative side effects. First, it crowds out private funding and hinders financial market development by reducing financial institutions’ incentives to develop credit evaluation and risk management skills. Instead, it encourages them to rely on government credit guarantees. MSMEs also have an incentive to rely on government loans, which tend to carry lower interest rates than loans from financial institutions. Second, government financing can delay the necessary restructuring and possible exit of MSMEs. This distorts resource allocation by limiting the scope for the entry of new firms and the expansion of innovative firms. Studies in Korea show that public programmes to support SME financing actually lowered the productivity of recipient firms and increased the survival probability of incompetent ones (Chang, 2016[37]). Third, the higher leverage of MSMEs resulting from government support can raise financial-sector risks. Fourth, public support can discourage some MSMEs from scaling up in order to continue receiving long-lasting public support and avoid the abrupt end to such support once they graduate from MSME status. Such firms thus fail to experience the productivity gains from scaling up (see above). In Japan, for example, the thresholds on capital in the definition of SMEs significantly discouraged investment by firms just below the limit. When the threshold was raised, the share of firms that increased their capital was significantly higher for those just below the threshold than for those already above the threshold or well below it (Tsuruta, 2017[47]).
Government policies to promote the financing of MSMEs
MSMEs received 97% of their financing in 2023 through loans from commercial banks. Another 2% was provided by development financial institutions (DFIs), which the government established to develop and promote strategically important sectors. In 2016, DFIs’ had 94 loan schemes. Direct government lending through DFIs offers advantages such as targeted allocation, flexibility, customised financial products, and risk mitigation. According to a 2019 SME Corp. survey, 36.1% of MSMEs seeking new or additional financing applied to banks and 11.5% to DFIs. Outstanding bank loans to MSMEs rose steadily over 2010-17, accounting for about half of total business lending, before edging down before the pandemic (Figure 4.26, Panel A). New lending to MSMEs has trended down since 2012, reducing its share to below 30% (Figure 4.26, Panel B). Impaired loans to MSMEs in 2020 were 3.2% of their total loans, slightly below the 3.4% of total business lending. In 2023, 50% of outstanding borrowing by MSMEs was used for working capital, 17% for construction, 9% for purchase of land and 6% for fixed assets other than land and buildings (Bank Negara Malaysia, 2024[48]).
Source: OECD (2022), Financing SMEs and Entrepreneurs 2024: An OECD Scoreboard | en | OECD.
The financing gap seems to be a problem particularly for micro firms, which received only 17% of new loans to MSMEs in 2023 (Figure 4.27, Panel A), although they account for around three-quarters of MSMEs. Moreover, loans over MYR 1 million (USD 209 thousand) accounted for almost three quarters of lending, suggesting that banks focused on larger firms in the MSME category (Figure 4.27, Panel B).
Note: Includes loans from commercial and development financial institutions. The size of the loans in Panel B are in MYR.
Source: Bank Negara Malaysia (2024), Financial Inclusion Data for Malaysia - Bank Negara Malaysia (bnm.gov.my).
In 2017, 88.3% of government support for MSMEs was used to provide funding, focusing on innovative new sectors, social inclusion and Bumiputera firms, i.e., firms owned by ethnic Malays and other indigenous peoples (Box 4.6). This indicates that financing is the key stumbling block for MSMEs. Financing programmes aimed to reach nearly 400 000 MSMEs, almost half of the total in 2017 (OECD/ERIA, 2018[49]). In addition to direct lending and guarantees, the government provides grants (eight schemes as of 2016) and equity (14 schemes) to MSMEs in all sectors and stages of development (SME Corp., n.d.[50]). For example, the provides grants to firms to help them introduce automation technology.
In 1971, Malaysia launched the New Economic Policy (NEP) to promote national unity and foster nation-building by eradicating poverty. It also aimed to restructure society by improving the well-being of Bumiputera (literally “sons of the land”), which refers to the Malays and indigenous people. Bumiputera accounted for 63% of Malaysia’s population in 2023, with smaller population shares accounted for by ethnic Chinese (20%), ethnic Indians (6%) and foreigners (10%). The Bumiputera agenda continues to be a national agenda to improve the economic status of the Bumiputera population for attaining fair, equitable and inclusive growth. The NEP included a target that by 1990, Bumiputera should own at least 30% of corporate equity. The 2015-2019 Eleventh Malaysia Plan added that Bumiputera should have 30% ownership with “effective control”.
The NEP has transformed Malaysia by promoting Bumiputera’s participation in higher education, high-level occupations, enterprise management and wealth ownership (Lee, 2021[51]). In addition to subsidies, the Bumiputera were granted other advantages including quotas in university enrolment, government contracts and procurement, business licences and loans, and employment in the civil service and government-related entities. While the NEP presented a broad vision of a greater economic role for Bumiputra, the 30% equity target has received disproportionate attention. Bumiputera’s share of equity ownership increased from 2.4% in 1970 to 16.9% in 2018 (Table 4.4). The failure to achieve the target reflects the liberalisation of a number of economic sectors, including the relaxation of the condition of 30% Bumiputera equity ownership in the manufacturing sector, which led to divestment to non-Bumiputera and foreigners.
1. “Nominee companies” are firms that join joint ventures with foreign companies to meet ownership requirements for foreign direct investment. Local shareholders waive their economic interest and voting rights.
Source: Economic Planning Unit.
The Twelfth Malaysia Plan stated, “the key issues faced by Bumiputera are the inequitable distribution of income, the high incidence of poverty and unemployment rate as well as the high concentration in low-skilled occupational categories”. The incidence of absolute poverty among the Bumiputera in 2022 was 7.9%, compared to the national average of 6.2% and 1.9% among the Chinese. The median income of Bumiputera households has risen from 67% of the national average in 1974, shortly after the launch of the NEP, to 91% in 2022.
Bumiputera are primarily involved in micro, low value-added businesses. Bumiputera entrepreneurs have a “high dependency on government assistance”, which provides financial assistance to support start-ups and the expansion of existing firms through a range of targeted programmes (Ministry of Economy, 2021[2]). The Twelfth Malaysia Plan reaffirmed the target of boosting Bumiputera’s share of corporate equity ownership to at least 30% by 2025, although there are difficult measurement issues involved in calculating Bumiputera’s equity ownership, such as the exclusion of government ownership.
While the NEP has significantly narrowed inequality between the Bumiputera and other ethnicities, it has also been criticised for negative side effects. Some have argued that this has encouraged rent-seeking behaviour and government patronage and hindered the development of the Bumiputera communities’ capability and competitiveness, with adverse effects for the Malaysian economy (Lee, 2021[51]). The NEP also has negative implications for trade, as it mandates the allocation of a portion of government procurement to firms with Bumiputera ownership.
The significant progress in narrowing the income gap raises the question of whether the negative side effects of current policies now outweigh their benefits. Given the decline in income inequality between Malaysia’s different ethnicities, a gradual phasing out of the NEP, accompanied by expanding social assistance for all low-income households (Chapter 2) and greater emphasis on policies promoting the scaling up all MSMEs may be beneficial for Malaysia.
Around half of MSMEs that received loans in 2022 pledged collateral, which on average was about 55% of the loan amount (OECD/ERIA, 2018[49]). Many firms with no or inadequate collateral and an insufficient financial track record cannot obtain financing, or if they do, the amount is insufficient. Moreover, some firms do not even apply due to their lack of financial literacy, negative perception of financial markets or preference to avoid debt. To help such firms, Malaysia uses credit guarantees to enable MSMEs to increase their access to financing and/or reduce its cost. Guarantees reduce the risk to lenders, prompting them to offer better rates, terms and conditions. According to a 2019 government survey, two-thirds of MSME loan applications were approved with collateral and/or guarantees. The 2024 federal budget earmarked MYR 20 billion (1.0% of GDP) to provide additional guarantees to MSMEs, with particular attention to those involved in the green economy, technology and halal sectors. Malaysia has two major guarantee providers:
The Credit Guarantee Corporation Malaysia Berhad (CGC), established in 1972, had provided 442 000 financing packages valued at MYR 63.7 billion (USD 13.3 billion) by 2017 (OECD/ERIA, 2018[49]). The CGC and the partner financial institutions share the risks. The CGC guarantees loans up to MYR 500 000 (USD 105 000). At the end of 2022, the CGC’s outstanding stock of guarantees was MYR 21.9 billion (1.1% of GDP).
The Syarikat Jaminan Pembiayaan Perniagaan Berhad (SJPP) was created in 2009 as a wholly-owned company of the Minister of Finance, Incorporated to provide guarantees for loans to MSMEs. The government determines the terms for each of the nine SJPP guarantee schemes provided by the 22 participating banks. Thus far, the SJPP has assisted more than 100 000 SMEs, with a total value of guarantees exceeding MYR 80 billion. Taking account of repayments and settlements, the outstanding stock of guarantees is MYR 37.3 billion (1.9% of GDP).
Malaysia’s credit guarantee schemes for MSMEs follow best practices by setting guarantees below 100% of the loan so that the lending institution has “skin in the game”. Completely guaranteeing loans would weaken market forces as banks have less incentive to monitor such loans, as they do not face a loss in case of default. Moreover, in Malaysia, before the credit guarantor approves the claims, it needs to be satisfied that the banks have fulfilled their responsibility in collecting the debt. Still, lowering the ratio to the 75-80% range typical in OECD countries would further strengthen incentives for banks. Once loans are given to a firm, financial institutions and credit guarantee providers share a common interest in its survival, as a default would result in losses for both of them. To delay or prevent such a loss, they may continue to support the firm, a phenomenon referred to as “evergreening”, which facilitates the survival of “zombie firms”, and slows economic growth. In addition, it is essential to ensure that loans support new firms rather than artificially extend the life of non-viable firms, allowing them to continue to compete with unsupported firms. In Malaysia, 47% of the firms receiving guarantees were at least ten years old. Limiting the length of guarantees would increase the share of young firms among beneficiary firms, thereby ensuring that support for older firms does not crowd out young enterprises (Jones and Lee, 2016[52]).
Greater MSME access to alternative financing models would be beneficial
Given MSMEs’ reliance on bank loans for 97% of their external financing, measures to improve their access to lending is crucial. At the same time, it essential to expand other financing sources. While Malaysia’s entrepreneurial ecosystem as a whole compares favourably with neighbouring countries, the lack of risk capital is an obstacle (Global Entrepreneurship and Development Institute, 2019[53]). In 2023, own cash – retained earnings and family and friends – accounted for nearly three-quarters of financing for firms less than six years old (Figure 4.28). Such sources of financing stifle firm creation as entrepreneurs risk “losing it all” (Kuriakose et al., 2022[54]). Moreover, many MSMEs are risk-averse and prefer to avoid debt or at least limit it. Equity financing plays a minor role, even for firms more than 15 years old. In 2023, equity accounted for only 2% of MSMEs’ funding. The government aims to transform Malaysia into a top 20 global start-up ecosystem by 2030.
In 2023
Source: Bank Negara Malaysia (2024), Financial Inclusion Data for Malaysia - Bank Negara Malaysia (bnm.gov.my).
Bank loans, which account for 98% of MSME external financing, are better suited to more established businesses with proven track records. However, they are less suitable for high-risk, high-growth start-ups and early-stage firms, which tend to have limited collateral and uncertain revenues in the short run. Meeting MSMEs’ financing needs instead requires greater reliance on alternative funding sources, as “the traditional forms of financing are found increasingly to be inadequate” (OECD, 2024[55]). The Twelfth Malaysia Plan aims to develop “a vibrant alternative financing to complement the banking system” (Ministry of Economy, 2021[2]). Equity financing would be a more suitable instrument for MSMEs, but it is difficult for them to access the Bursa Malaysia, one of the largest stock markets in ASEAN countries. The government has created two additional markets tailored toward smaller firms:
The ACE Market, established in 2009 with lower listing requirements, provides a platform for small and growing companies to raise capital. Currently, 176 firms are listed on the ACE Market. However, its market capitalisation is less than 1% of GDP compared to 12% for KOSDAQ, which plays a similar role in Korea.
The Bursa Malaysia launched the Leading Entrepreneur Accelerator Platform (LEAP Market) in 2017. Given the higher risk involved, only experienced investors and high net-worth individuals or entities can invest in LEAP companies. The LEAP market is aimed in part at Bumiputera firms. A company must have a Bumiputera ownership share of at least 12.5% to be eligible for the LEAP market. In 2018, the government announced an initiative to reduce the cost of listing in order to encourage at least 100 Bumiputera companies to join the LEAP Market and will reimburse the cost for Bumiputera firms that have already joined (OECD/ERIA, 2018[49]). By 2023, 48 companies had listed on the Leap Market, with total market capitalisation amounting to MYR 5.5 billion (USD 1.15 billion).
New ways of accessing equity, including venture capital, private equity, equity crowdfunding and peer-to-peer financing, can help overcome market failures. Venture capital in Malaysia is relatively small relative to its GDP compared to other countries in the region (Figure 4.29), suggesting significant scope for growth. Moreover, the average deal size for seed funding is also low compared to its regional peers, suggesting a lack of high-quality investment opportunities. Indeed, the modest levels of R&D and knowledge creation in Malaysia may limit the number of deals below that required to facilitate the emergence of a vibrant venture capital industry. Increasing R&D in line with the government’s target, as noted above, would help spark an increase in venture capital. The number of registered venture capital corporations stood at 106 at the end of 2021, with total committed funds of MYR 5.2 billion (USD 1.2 billion). In 2020, 108 venture capital deals were recorded, focusing on early stage firms (50.5%) and growth (38.9%) (OECD, 2022[56]). Venture capital investment is skewed toward more established, later-stage firms (Kuriakose et al., 2022[54]).
Malaysia’s share of venture capital deals and GDP among five other Southeast Asian peers
Source: Kuriakose, S. et al. (2022), Malaysia - Assessment of the Start-Up Financing Ecosystem.
A large share of venture capital-backed deals are funded by public-sector entities such as government agencies and government-linked investment companies (45.0%) and sovereign wealth funds (27.9%), suggesting a need to crowd-in greater private-sector funding. Given significant untapped liquidity in the corporate sector, its share of venture capital funding could be raised above its current level of 19.7%. The Angel Tax Incentive Office was established in 2013 to encourage early-stage investments by private-sector angels. However, Malaysia’s major weakness in venture capital, according to the Venture Capital and Private Equity Country Attractiveness Index, are administrative burdens and the slow implementation of a range of tax incentives to encourage additional investment (Groh et al., 2023[57]). A World Bank study stated that “improving the clarity of the legal and regulatory framework for the VC industry is essential to enhance investor confidence and to crowd-in a higher degree of private venture capital funds” (Kuriakose et al., 2022[54]).
Private equity (capital invested in an entity not publicly listed or traded) is another investment channel. In 2020, Malaysia had 21 private equity firms and a total of MYR 9.65 billion (USD 2.3 billion) in committed funds. Primary sources of funds are corporate investors (31.5%), individuals and families (17.1%) and fund-of-funds and other asset managers (13.1%). In 2020, 29 private equity deals were recorded. Private equity in Malaysia is still skewed toward leveraged buyout exits rather than growth-stage investments in terms of the relative number of deals. In contrast to venture capital, government entities and sovereign wealth funds account for less than 2% of the investment (Kuriakose et al., 2022[54]).
The Securities Commission Malaysia (SC) has facilitated the development of alternative financing platforms that connect firms with traditionally untapped pools of investors through cheaper, faster and more convenient non-banking channels. These include equity crowdfunding and peer-to-peer (P2P) (OECD, 2024[55]). The Malaysia Co-Investment Fund (MCIF) was established in 2019 to co-invest in MSMEs with private investors through equity crowdfunding and P2P platforms. Thus far, the MCIF has co-invested over MYR 357 million (USD 75 million) in 16 000 campaigns involving 2 280 firms (0.2% of MSMEs).
Equity crowdfunding: In 2015, Malaysia became the first ASEAN country to establish a framework for equity crowdfunding (which differs from rewards and donation crowdfunding). It now has ten operators registered with the Securities Commission. In 2020, total capital raised grew by more than five-fold to MYR 127.7 million (USD 37 million) via 80 campaigns, with about half the amount concentrated in firms in the pre-seed and seed funding stages. Online crowdfunding platforms allow entrepreneurs and firms to showcase their projects to more potential investors than conventional forms of raising capital. The process is less burdensome than the more traditional Initial Public Offerings (IPOs) approach. Most of the fundraising was by technology-focused issuers based primarily in Kuala Lumpur and Selangor aiming to expand their businesses. Around 45% of the campaigns raised more than MYR 0.5 million (USD 105 000) in 2020 (Kuriakose et al., 2022[54]).
Peer-to-peer financing (P2P): Malaysia has 11 P2P lending platforms registered with the Securities Commission. This approach, which usually occurs on third-party platforms that function as matchmakers connecting lenders with borrowers, raised total capital of MYR 503.3 million (USD 105 million) in 2020. A total of 1 325 issuers successfully participated in 7 760 campaigns. Compared to equity crowdfunding, P2P generally raised smaller amounts: 74% of the campaigns generated less than MYR 50 000. Another difference is that three-quarters involved terms of three months or less, usually for working capital. P2P is similar to equity crowdfunding in its concentration in Kuala Lumpur and Selangor (63% of issuers) and its focus on technology (36%).
New financing methods, such as equity crowdfunding and P2P, have proven successful in some countries helping firms raise capital without incurring new debt. In Malaysia, however, they are still in a nascent stage, reflecting MSMEs’ lack of awareness and financial literacy. Moreover, MSMEs may find alternative financing methods unattractive due to the loss of ownership, costly administrative procedures and increased scrutiny.
Creating an appropriate regulatory framework for new forms of attracting equity is crucial to ensure its success and protect all parties involved. Unlike conventional capital-raising methods for early-stage companies, which primarily rely on investments from a small group of professional investors, equity crowdfunding targets a broader range of investors. With numerous small shareholders participating, protecting investors by ensuring transparency and preventing fraudulent activities is crucial. To address the concerns of numerous small shareholders, companies seeking crowdfunding should be required to disclose relevant information to investors and regulatory authorities. For example, in the United States, transactions must take place online through a Securities and Exchange Commission intermediary. Restrictions on the amount individual investors can invest and the participation of non-accredited investors are also needed. A balanced regulatory framework can enhance market confidence, encouraging more investors to participate in crowdfunding while avoiding excessively stringent regulation could stifle creativity and hinder its growth.
Greater access to funding, both direct and indirect, for MSMEs also depends on enhancing their financial literacy. The G20/OECD High-Level Principles on SME Financing (2015) stated that “public policies should champion SMEs’ enhanced financial literacy and their awareness and understanding of the broad range of available financial instruments” (G20/OECD, 2015[6]). Numerous studies in Malaysia have found a positive relationship between MSMEs’ performance and the financial literacy skills of their owners and managers. This includes their understanding of such topics as debt, savings, insurance and investment (Yakob et al., 2021[58]). The government has taken steps to improve financial literacy through the combined efforts of 60 Entrepreneurship Development Organisations, DFIs and commercial banks. It also launched the five-year National Strategy for Financial Literacy in 2019 to foster financial awareness and increase access to financial management tools and resources. The Financial Education Network monitors the implementation of the Strategy, focusing on MSMEs and low-income groups (Financial Education Network, 2023[59]). Policies implemented in Mexico and Canada (Box 4.5) have useful measures that contribute to management capabilities and financial literacy.
Enhancing MSMEs role in international trade
The Mid-Term Review of the Twelfth Malaysia Plan stated that integrating MSMEs into global value chains is a key to their scaling up (Ministry of Economy, 2023[9]). Selling products and services in foreign markets increases the probability that an MSME will scale up and achieve a high-growth episode. This could result from self-selection; better-performing firms are more likely to choose to become exporters or seek foreign partnerships (Grover Goswami, Medvedev and Olafsen, 2019[8]). However, the OECD study of European MSMEs found that future high-growth firms began exporting before they started scaling up. Indeed, their propensity to trade was similar to the larger firms to which they eventually caught up. In other words, the increased trade of future scaler firms was not a random episode resulting from greater foreign demand, but rather a strategic decision to experiment with more products and destinations (OECD, 2021[14]). This suggests that policies to increase MSME integration in global markets should be part of government policies to support the scaling up of small firms.
Firms with global linkages tend to be larger, more productive and profitable, pay higher wages and have higher rates of technology adoption. Global exposure can improve MSMEs’ performance as they “learn from exporting” how to improve product quality. It also allows MSMEs to optimise their sourcing strategies by giving them access to less expensive and more advanced imported products and services and to obtain foreign technology (OECD, 2021[14]). In Malaysia, firms’ investment in digital assets and solutions is positively correlated with exporting (Kuriakose et al., 2022[27]).
Large firms dominate Malaysia’s exports. Exports account for at least 10% of revenues for 50% of large firms and 12% of medium firms, but less than 5% of small firms (Figure 4.30, Panel A). The proportion of Malaysian small firms that meet the 10% threshold is low compared to other countries (Figure 4.30, Panel B). MSMEs’ share of Malaysia’s exports dropped significantly with the outbreak of COVID-19, reducing the share from 17.7% in 2015 to 10.5% in 2022, even as MSMEs’ share of GDP and employment remained level (Figure 4.31, Panel A). A 70% drop in services exports, reflecting the sharp drop in tourism during the pandemic, was primarily responsible for the decline (Figure 4.31, Panel B). However, MSMEs’ service exports failed to rebound in 2022, even as Malaysia’s total exports increased by 25% in value terms.
Note: Panel B shows the share of small firms for which exports (direct or indirect) account for at least 10% of sales.
Source: Kuriakose, S. and H. Tiew (2022), Malaysia: SME Program Efficiency Review.
Source: Department of Statistics Malaysia (2023), Micro, Small & Medium Enterprises Report 2022.
One of the “game-changers” in the Twelfth Malaysia Plan is to shift MSMEs from domestic to global markets and raise their share of total exports to 25%. The low share of exports reflects the fact that only a fifth of MSMEs supply goods and services to large firms, which instead source inputs primarily from other large firms and from overseas (Ministry of Economy, 2023[9]). The government’s Inclusive Business model aims to strengthen MSME participation in the value chains of government-linked companies and multi-national corporations in high-impact industries. Foreign investors can claim tax deductions for costs involved in providing support to local suppliers, including training, product development and testing, and factory auditing to ensure the quality of local suppliers.
Moreover, government procurement will be fully leveraged to support MSMEs in the domestic market (Ministry of Economy, 2021[2]). Government procurement has long given preferential treatment to MSMEs and to firms owned by Bumiputera (Lee, 2021[51]). In 2018, 29 OECD countries had policies to enhance SMEs’ access to public procurement through various means, such as promoting joint bidding of SMEs with large companies, breaking large contracts into lots to enable SMEs to bid, and e-procurement to facilitate the bidding process (Jones and Lee, 2018[60]). Such policies helped to create a more level playing field for SMEs, while maintaining efficiency-enhancing competition. However, reserving a certain amount of procurement for SMEs can have the unintended side effect of increasing dependency on public support and slowing productivity gains. In Korea, for example, SMEs chosen for public procurement in 2009 had significantly lower productivity in 2011 (Jones and Lee, 2018[60]).
Malaysia’s membership in key multilateral and bilateral trade agreements offers significant export opportunities, including to MSMEs. In 2022, Malaysia joined two of the world’s largest trade agreements; i) the Regional Comprehensive Economic Partnership (RCEP), which includes the ten ASEAN members and China, Korea, Australia, Japan and New Zealand; and ii) the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPTPP), which allows Malaysia preferential access to Canada, Mexico, and Peru, which had not been part of Malaysia’s previous free trade agreements (FTAs). CPTPP goes beyond traditional FTAs by addressing the development of the digital economy and the role of MSMEs in the global economy. RCEP and the CPTPP allow MSMEs to access a broader market of about 2.3 billion. In addition, as a member of ASEAN, Malaysia has regional FTAs with China, Japan, Korea, India, Australia, New Zealand and Hong Kong, China. Moreover, Malaysia has bilateral FTAs with seven countries (Australia, Chile, India, Japan, New Zealand, Pakistan and Turkey). These agreements reduce tariffs and trade barriers, simplify export procedures, reduce administrative burdens and costs, and harmonise trade rules and regulations among member countries. The Twelfth Malaysia Plan stated that the government will “leverage the benefits of FTAs in widening market access and accelerating the internationalisation of MSMEs”. It also pledged that “the ‘Buy Malaysia Campaign’ will be intensified to support local MSMEs”, though this could run counter to international trade agreements (Ministry of Economy, 2021[2]).
However, many MSMEs lack the expertise to utilise these agreements effectively, thus limiting their entry into new markets and global supply chains. The Ministry of Investment, Trade and Industry (MITI) is encouraging MSMEs to explore overseas markets through its trade promotion agency, MATRADE. Its Export Readiness Assessment Tool (ERAT) is a free online service to assess firms’ export capability. MATRADE also uses its network of 49 overseas offices to help match foreign buyers with local companies. In some countries, MSMEs have created export consortia to increase their role in international trade (Box 4.7).
Malaysia would benefit from laying the foundations for reaching FTAs with other major economies. This includes removing barriers to foreign participation in government procurement and considering adhering to the WTO Government Procurement Agreement, which would likely help to reach new trade agreements as it has been a stumbling stone in earlier FTA negotiations. This could be part of efforts to de-emphasise ethnic ownership targets in favour of promoting the scaling-up of all MSMEs, which would greatly benefit Bumiputera (Box 4.6).
Trade agreements also address e-commerce and digital trade regulations, providing a framework for MSMEs to expand their business operations beyond national borders. The National E-Commerce Strategic Roadmap 2.0 aims to triple the number of MSMEs using e-commerce to export from 27 000 in 2020 to 84 000 in 2025. In the digital era, trade involves complex regulatory frameworks related to electronic transactions, secured payment systems, intellectual property rights and cross-border digital services. The impact of digital trade barriers fall disproportionately on MSMEs, reflecting the higher compliance costs of diverging regulations across countries. Service trade barriers may result in an additional tariff equivalent that is as high as 7% on small firms’ cross-border exports compared to large firm (Rouzet, Benz and Spinelli, 2017[61]) . Smaller firms in Malaysia and other ASEAN countries are more likely to export if they have a web presence (López González, 2019[62]), making digitalisation a key to increasing their role in global trade. The OECD Digital Services Trade Restrictiveness Index, which measures the openness of the regulatory environments in these areas, shows that Malaysia is more open than the OECD average and other ASEAN countries (Figure 4.32). Malaysia has actively contributed to regional and international regulatory harmonisation in forums such as APEC and ASEAN (OECD, 2021[30]).
An MSME can significantly enhance its export potential and lower the costs and risks involved in entering foreign markets by forming an export consortium with other companies. An export consortium is a voluntary alliance of firms aimed at promoting the export of goods and services of its members through joint actions. This approach can help MSMEs overcome weaknesses that limit their participation in international trade, such as the lack of the necessary knowledge and financing, difficulty in meeting foreign regulatory requirements, and limited production quantities that are insufficient for foreign buyers. Participating firms retain their financial, legal, managerial, and commercial autonomy (UNIDO, 2024[63]).
Italy has a long tradition of export consortia. Each consortium must have at least eight SMEs (five in southern Italy). Government grants, which average EUR 2-3 million annually, are provided to finance visits abroad, workshops and advertising. In 2014, the government funded 110 consortia, which included over 1 600 companies. The Italian Federation of Export Consortia (Feder-export) assists the consortia by providing tax and legal advice, organising conferences and market surveys, and negotiating credit lines with banks to finance the consortia’s export activities (OECD, 2018[43]).
The export consortia has succeeded by helping SMEs attain the scale needed to internationalise. Moreover, the policy leverages government funds by channelling resources to a group of SMEs, rather than individual firms, spreading the financial benefits across a larger number of beneficiaries. The implementation costs are reduced because the government only interfaces with the leaders of the consortia. The collaboration and knowledge exchange can extend beyond the initial objective of increased export activity. However, one drawback is that turnover in government-supported consortia has been limited, as some have become overly dependent on government support (OECD, 2018[43]). Still, the export consortia approach could be successful in Malaysia, which has a long history of co-operatives. Other countries, such as Argentina, Brazil, India, Morocco and Tunisia, have created export consortia and the OECD has recommended this approach to Indonesia (OECD, 2018[43]).
Malaysian companies must be prepared to meet Environment, Social and Governance (ESG) standards to participate in global supply chains. Key global ESG regulatory standards include the EU’s Carbon Border Adjustment Mechanism and Sustainable Finance Disclosure Regulation, the UK Sustainability Disclosure Requirements, and the German Supply Chain Due Diligence Act. Already in 2022, almost 9 600 companies with a total market capitalisation of USD 98 trillion (87% of the world total) disclosed sustainability-related information (OECD, 2024[64]). In 2023, Malaysia became the first country in the world to provide MSMEs operating in global supply chains with a streamlined and standardised set of guidelines in relation to ESG. The guidelines were prepared by Capital Markets Malaysia, an affiliate of the Securities Commission Malaysia (SC). In addition, the New Industrial Master Plan 2030, launched in 2023, aims to “build SMEs’ ESG capacity to help secure their continued participation in ESG-compliant MNC vendor ecosystems” (Minister of Investment, Trade and Industry, 2023[34]). Such measures will also help MSMEs join international value chains.
0 (open) to 1 (closed)
Note: Other refers to intellectual property rights and other barriers affecting trade in digitally enabled services.
Source: OECD, Services Trade Restrictiveness Index database.
Regulatory reform to facilitate the scaling up of MSMEs
A regulatory environment that fosters competition and encourages business dynamism can be instrumental to boost MSME productivity, while burdensome regulations can limit MSMEs’ ability to scale up (Andrews, Criscuolo and Gal, 2015[65]). Productivity-limiting regulations not only reduce the number of firms able to attain high growth but are also likely to misallocate resources in a way that allows less efficient firms to achieve high growth (Grover Goswami, Medvedev and Olafsen, 2019[8]). Malaysia launched the Modernising Business Regulation programme in 2007 to boost the country’s productivity by reforming the regulatory structure (OECD, 2018[66]). The Twelfth Malaysia Plan identified “restricted market access” as a key factor responsible for MSME weakness (Ministry of Economy, 2021[2]). The Malaysia Productivity Corporation (MPC) is responsible for regulatory reviews to reduce red tape and bureaucratic hurdles to doing business. It estimates that there are 3 295 regulations comprising acts, regulations, permits and licences at the federal government level, covering the company life cycle from creating, operating and closing a business. Together, these regulations impose an estimated MYR 45 billion (2.3% of GDP) in compliance costs annually (Malaysia Productivity Corporation, 2023[40]).
Regulations require firms to monitor their suppliers, staff and operations, to report their compliance performance and show proof of licensing and permit applications. Many regulatory requirements are imposed by multiple agencies, increasing the time and resources needed for MSMEs to comply. Among informal entrepreneurs, around 40% reported that fees and the required documents and legal procedures discouraged them from formalising their operations (Ministry of Entrepreneur and Cooperatives Development, 2024[67]). In a 2018 survey of more than 2 000 MSMEs by the SME Corp. and Huawei, 37% said that they needed help with three tasks: i) regulatory compliance related to their business field; ii) process guidance for operating; and iii) meeting licensing and permit regulations (Figure 4.33). Another 29% required assistance for two of these tasks.
Note: Based on a survey of 2 033 MSEMs asking if they need assistance in three tasks; i) compliance; ii) process guidance; and iii) licensing & permits.
Source: SME Corp. and Huawei. (2018), Accelerating Malaysian Digital SMEs: Escaping the Computerisation Trap.
The MPC cited eight specific issues related to bureaucracy and red tape in Malaysia in their 2023 report that are key to reducing the regulatory burden (Malaysia Productivity Corporation, 2023[40]):
Lengthy processing time: Permission for land conversion, for example, may take more than one year in some localities, reflecting a multiple-stage decision-making process. Risk-averse regulators may prioritise low-risk applications from businesses for fast processing.
Complex, numerous and overlapping procedures: Applicants must often submit similar information to different agencies and regulators using forms and formats particular to each agency. A standardised application in a format acceptable to multiple agencies and creating “one-stop shops” would save time and money. In addition, digitalising the processes would simplify applications.
Sequential work process: Many applications for licenses and permits require step-by-step approval from various agencies and regulators. Rather than waiting for the completion of one approval before advancing to the next step, allowing steps to be accomplished simultaneously would save time.
Lack of transparency and clarity: Difficulty understanding regulations creates confusion and unpredictability for firms and may result in a misinterpretation of regulations. Making clear and precise guidelines for regulatory compliance available online would help resolve this issue.
Obsolete and outdated regulations: In today’s fast-changing economic landscape, regulations can quickly become outdated, making them unclear and ineffective. To keep regulations up to date, frequent regulatory reviews are needed using the “guillotine” approach to identify and eliminate unnecessary and burdensome regulatory requirements.
Corruption and abuse of power: Corruption increases the cost of doing business and creates an uneven playing field for businesses, thereby reducing trust and confidence in the government. Digitalising regulatory procedures decreases the risk of corruption by minimising in-person dealings.
Inconsistent enforcement of regulations: Inconsistency leads to a lack of predictability, which is particularly harmful for investors, given their need for precise and accurate information. Centralising the regulatory procedures necessary for a specific project through a digital end-to-end, one-stop centre platform would standardise regulatory requirements.
Manual processing of regulatory processes and procedures: Manual processing of documents to comply with regulatory requirements is still widely practised even though digital platforms are available. Shifting to digital platforms by educating regulators and the public would reduce time and costs.
The burdens imposed by Malaysia’s regulatory policies on product market competition are high compared to OECD countries (Figure 4.34). Moreover, Malaysia ranks worse than all but four OECD countries in the complexity of its regulations (OECD-WBG, 2023[68]). The OECD Product Market Regulation (PMR) indicator assesses the extent to which regulations support or restrict competition in key sectors of the economy. This ranking is confirmed by the IMD’s World Competitiveness Ranking, which places Malaysia 45th in business legislation (IMD, 2023[69]). While Malaysia ranks well behind OECD countries, its regulations are less restrictive than in large non-OECD countries covered by the indicators, including Indonesia and China.
Overall Product Market Regulation indicator, index scale of 0-6 from least to most restrictive
Note: Information used to calculate the OECD’s 2018 PMR indicators is based on laws and regulations in place on 1 January 2018 or a later year (1 January 2020 for Malaysia).
Source: OECD, Product Market Regulation database; and OECD-WBG, Product Market Regulation database.
The ease of starting a new business is a critical determinant of firm creation. Malaysia, which has a lower firm creation rate than the OECD average, has a relatively high administrative burden on new start-ups according to the OECD’s PMR index, which is based on 2020 for Malaysia (Figure 4.35). The PMR index also shows that the burden of licenses and permits is higher than all but two OECD countries. The PMR result is consistent with the World Bank’s 2020 Doing Business Index, which ranked Malaysia 126th in its indicator of starting a business.
Product Market Regulation indicator: Administrative burdens on start-ups, Index scale of 0-6 from least to most restrictive
Note: Information used to calculate the OECD’s 2018 PMR indicators is based on laws and regulations in place on 1 January 2018 or a later year (1 January 2020 for Malaysia).
Source: OECD, Product Market Regulation database; and OECD-WBG, Product Market Regulation database.
The government has taken measures to address some of the key issues noted above that were cited by the MPC. In 2020, the government launched the MalaysiaBiz portal as a one-stop centre to manage business registration and licensing. This has helped make business registration more affordable and efficient, with registration fees ranging from MYR 30-60 and a registration time of four to five working days. In comparison to business registration, the process for obtaining the necessary licenses and permits to operate in Malaysia is significantly more burdensome. According to the 2023 Global Business Complexity Index (GBCI), Malaysia is the 21st most complex country in the world to do business. The Index compares differences in the rules and requirements for doing business in 78 jurisdictions around the world. Malaysia has improved from its ranking as ninth in 2020, suggesting that reform efforts have had an impact. Moreover, Malaysia is viewed more favourably than Indonesia (11th) and China (15th). Still, Malaysia has room for further improvement towards the Philippines (31st), India (33rd), Viet Nam (46th), Thailand (52nd) and Singapore (59th) (TMF Group, 2023[70]).
As noted above, 85% of MSMEs are in services, of which nearly half are in the retail sector, according to the 2016 census. Labour productivity in the retail and food and beverage sectors fell slightly below half of the national average after being hit hard by the pandemic (Figure 4.36). A more efficient retail sector may emerge, driven by the investments made to cope with COVID-19.
Source: Department of Statistics Malaysia (2023), Micro, Small & Medium Enterprises Report 2022; and Malaysia Productivity Corporation (2023), MPC_Productivity Report 2023.pdf (cdn-website.com).
However, Malaysia’s retail sector faces stricter regulations than the OECD average (Figure 4.37). Foreign-owned retailers are subject to a separate regulatory regime in Malaysia, which imposes restrictions on their floor size and opening hours, thus limiting competition (OECD, 2021[30]). A small retail store may require as many as ten different licenses, permits and approvals to operate (Malaysia Productivity Corporation, 2023[40]).
Product Market Regulation indicator: Retail sector regulations, Index scale of 0-6 from least to most restrictive
Note: Information used to calculate the OECD’s 2018 PMR indicators is based on laws and regulations in place on 1 January 2018 or a later year (1 January 2020 for Malaysia).
Source: OECD, Product Market Regulation database; and OECD-WBG, Product Market Regulation database.
One key issue is price controls; the government sets the maximum price of around a dozen essential goods, including sugar, petrol and diesel. The government implemented a broad anti-profiteering framework to protect consumers from excessive price rises following the introduction of the Goods and Services Tax. It allows the government to take action against retailers whose profits exceed “reasonable” levels as determined by the government. Although the tax has been abolished, the price regulation remains in place.
Compared to OECD countries, price controls are prevalent in Malaysia (Figure 4.38). A World Bank survey found that half of firms in Malaysia are affected by price controls (World Bank, 2023[32]). Price controls tend to inhibit business dynamism by limiting business strategies and limiting product market competition, which is key to productivity gains. Price controls also reduce incentives for firms to increase supply and scale up. The World Bank survey found that of the firms affected by price controls, 37% reported that they reduced production by an average of 24%, which leads to shortages that put upward pressure on prices. Moreover, the survey found that “the burden of price controls falls disproportionately on smaller firms as compared to medium and large-sized firms that could pivot away from price-controlled products” (World Bank, 2023[32]). In addition, reporting requirements under the anti-profiteering framework create an administrative burden for firms, particularly MSMEs. The removal of price controls should be accompanied by strong competition policy to limit monopoly pricing power and by appropriate pricing policies for natural monopolies.
Product Market Regulation indicator: Price controls, Index scale of 0-6 from least to most restrictive
Source: OECD, Product Market Regulation database; and OECD-WBG, Product Market Regulation database.
Improving the insolvency framework can promote the scaling up of firms
Inefficient insolvency regimes can delay or prevent the failure of non-viable firms, thereby slowing the reallocation of workers and capital to successful enterprises. The survival of so-called “zombie” companies thus tends to slow the scaling up of successful firms (OECD, 2021[14]). In addition to the timely exit of non-viable enterprises, an effective insolvency framework can promote the successful restructuring of viable companies (André and Demmou, 2022[71]). The positive relationship between the ease of resolving insolvencies and business density suggests that a more efficient insolvency regime favours new business creation, in part by allowing second chances to “honest failed entrepreneurs” (OECD, 2021[30]).
Malaysia has reformed its insolvency and bankruptcy regimes. In 2016, amendments to the Companies Act introduced two new corporate rescue mechanisms. They were accompanied by additional controls on court-sanctioned schemes to make the process more effective in promoting effective corporate debt restructuring. According to the World Bank’s Doing Business Assessment by the World Bank, it takes one year on average to resolve insolvencies in Malaysia compared to the OECD average of about 1.7 years. Moreover, the recovery rate for secured creditors is 81 compared to an OECD average of 70 (OECD, 2021[30]).
Still, additional reforms could further improve Malaysia’s insolvency and bankruptcy regimes. In the 2019 Global Entrepreneurship Monitor (GEM) Survey, nearly 45% of adults in Malaysia who have identified attractive business opportunities would not start a business for fear of failure. Moreover, the cost of insolvency is relatively high in Malaysia at around 10% of the estate compared to Japan (4.2%) and Korea (3.5%), suggesting that there is scope for further streamlining of the process (OECD, 2021[30]). A disproportionately large penalty on failed entrepreneurs can discourage firm creation and encourage owners of non-viable enterprises to remain in business.
The government should pursue other reforms proposed in the 2021 OECD Economic Survey of Malaysia. First, Malaysia’s insolvency framework should distinguish between blameless and blameworthy bankruptcies, as in other common law jurisdictions, such as the United Kingdom. Second, Malaysia’s insolvency regime could also ease the penalty attached to failure by supporting debtors through more generous asset exemptions and access to credit after the commencement of insolvency proceedings. Third, creditor participation in insolvency proceedings should be strengthened. Under the current system, the sale of substantial assets of the debtor does not require approval by the creditors. Moreover, the creditor does not have the right to request information from the insolvency representative (OECD, 2021[30]).
The significant role of state-owned enterprises (SOEs), often referred to as government-linked companies or GLCs in the Malaysian context, poses obstacles to scaling up MSMEs. According to the OECD Product Market Regulation index, the scale of public ownership in Malaysia exceeds all OECD countries and approaches that in Viet Nam and China (Figure 4.39). This is partly related to Malaysia’s New Economic Policy (NEP), introduced in the 1971 to pursue economic development and increase the economic role and wealth of the Bumiputera (Gomez et al., 2018[72]) (Box 4.6).
SOEs in Malaysia are defined as “companies that have a primary commercial objective and in which the government has a direct controlling stake, i.e., the ability to appoint board members and senior management, make major decisions (e.g., contract awards, strategy, restructuring and financing acquisitions and divestments) either directly or through the seven government-linked investment companies” (OECD, 2013[73]). The share of SOEs among Malaysia’s top ten firms, as measured by the equally-weighted average of their shares of sales, assets and market value of the country’s top ten firms, is the fifth highest globally. Eight of the ten listed companies with the highest market value are SOEs and 35 SOEs were ranked among the top 100 listed firms in 2013. Together, they make up 42% of Bursa Malaysia’s market capitalisation. The number of GLCs and their subsidiaries increased from an estimated 1 158 in the 1990s (Adam and Cavendish, 1995[74]) to more than 68 000 at the federal level (Gomez et al., 2018[72]) and hundreds at the state government level (Gomez et al., 2018[75]). Measured by operating revenue or income, SOEs’ share exceeds 50% in utilities, transport, warehousing, agriculture, banking, information communications, construction and retail trade (Menon, 2017[76]).
Product Market Regulations: Distortions from state involvement, Index scale from 0 to 6, from most to least competition-friendly regulations
Source: OECD, Product Market Regulation database; and OECD-WBG, Product Market Regulation database.
The dominance of SOEs has been perceived as an obstacle to the growth of private companies by crowding out private investment and making it harder for privately owned firms to compete (Williams, 2023[77]). An empirical study found that when SOEs are dominant in a business sector, investment by private firms is significantly negatively affected. Conversely, when SOEs do not dominate an industry, the negative impact on private investment is not seen (Menon and Ng, 2017[78]). This affects MSMEs, as SOEs play a significant role in sectors where MSMEs are prevalent, such as retail and transport. Consequently, many SOEs compete directly with MSMEs, which limits their ability to scale up. This has been recognised by the National Economic Advisory Council which stated that “the government’s role as both a business owner and regulator of industries creates conflicts of interest that can give SOEs an unfair advantage over private firms” (National Economic Advisory Council, 2010[79]). For example, SOEs have preferential access to government procurement contracts and enjoy other benefits, including direct subsidies, concessionary financing, state-backed guarantees, and exemptions from antitrust enforcement and bankruptcy rules (Menon, 2017[76]).
Moreover, SOEs have had a negative impact on the fiscal situation. The 2016 OECD Economic Survey of Malaysia noted that although the federal government’s fiscal deficit had declined, the public sector’s overall deficit increased partly due to rising SOE-related expenditures (OECD, 2016[80]).
The strong role of SOEs has also been associated with governance challenges (Menon, 2017[76]). Along with their significant market power, the “lack of governance and transparency of SOEs hinder accountability and control of corruption” (World Bank, 2021[1]). SOEs’ special access to government and regulatory agencies can easily create a perception of cronyism and corruption, and appointments to key SOE positions have lacked transparency (World Bank, 2021[1]).
Reforming state-owned enterprises
Reforming SOEs has been on the policy agenda for some time. In 2010, the government proposed a shift away from Malaysia’s traditional approach of “large direct public investment (including through SOEs) in selected economic sectors”, given that “the size of SOEs and their mere presence may inhibit expansion of new firms” (National Economic Advisory Council, 2010[79]). At that time, the government had planned to divest SOEs in industries where the private sector is operating effectively and ensure SOEs operate on a strict commercial basis free of government interference (National Economic Advisory Council, 2010[79]). Nonetheless, the government’s share in the stock market rose further over 2011-15. At the same time, privatisations have posed governance challenges as well (Williams, 2019[81]).
The Twelfth Malaysia Plan stated that “the role of SOEs will be enhanced while a fairer and healthier competitive environment will be encouraged to improve market efficiency for the private sector to expand into domestic and international markets”, recognising the importance of a more level playing field for competition between SOEs and private firms. This is planned through prioritising investment in SOEs in strategic sectors while gradually reducing the role of SOEs in non-strategic sectors. The transfer of SOE assets in non-strategic sectors is meant to give preference to qualified Bumiputera entrepreneurs (Ministry of Economy, 2021[2]). In 2024, the government reaffirmed that SOEs remain committed to supporting the Bumiputera agenda (Malay Mail, 2024[82]).
The New Economic Policy has helped increase the median income of Bumiputera households from 67% of the national average in 1974 to 91% in 2022. The success in narrowing the income gap between Malaysia’s ethnic groups raises the question of whether the negative side effects of the NEP exceed its benefits. A gradual phasing out of current policies should include re-evaluating the costs and benefits of operating SOEs in sectors where the private sector is operating efficiently. This should be accompanied by increasing social assistance of all low-income households (Chapter 2) and effective policies to promote the scaling up of MSMEs.
In addition, it is essential to level the playing field between private firms and those that remain government-owned. International organisations including the World Bank (World Bank, 2021[1]) and the IMF, in its 2023 IMF Article IV on Malaysia, have called for “increased transparency of SOE operations” (IMF, 2023[83]). This requires improving SOE management structures and corporate governance. The independence of SOE boards should be respected and protected from political influence, in line with the OECD State-Owned Enterprise Guidelines (OECD, 2015[84]). This would protect the minority shareholder rights of private entities (Gomez et al., 2018[72]). The Twelfth Malaysia Plan stated that “more stringent processes will be put in place in appointing board members, based on merit, integrity, technical, financial and corporate governance skills” (Ministry of Economy, 2021[2]). Not allowing politicians to serve on SOE boards would be an important step in reducing political influence (World Bank, 2021[1]). Despite efforts to limit the role of politicians in SOEs, politicians continue to be appointed to board and chairman positions, thereby threatening the autonomy of SOEs. Malaysia may wish to consider the experience of Brazil where the 2016 SOE Statute has helped reduce political interference in the management of SOEs and advance the professionalisation of its boards by establishing clear rules for the appointment of directors, including minimum experience, academic background, and morality requirements, as well as a minimum “cooling off” period if coming from political office (Vitale et al., 2022[85]).
The role of government-linked investment companies
SOEs are closely connected to Malaysia’s government-linked investment companies (GLICs) (Table 4.5). These are defined as “investment companies in which the federal government has influence over the management by appointing and approving board members and senior management, who in turn report directly to the government” (OECD, 2013[73]). The government oversees GLICs and participates in their board through the Ministry of Finance or the Prime Minister’s office. The Minister of Finance is ultimately responsible for appointing directors (IMF, 2013[86]). The Prime Minister has stated that “GLICs play an important role in Malaysia’s economic development and nation building” and have been” a key pillar of the national economy since the 1970s” (Ministry of Finance, 2021[87]).
Source: Gomez, E. et al. (2018), Minister of Finance Incorporated: Ownership and Control of Corporate Malaysia (repec.org).
Among the seven GLICs, there are a number of institutional types – a special purpose fund, a sovereign wealth fund, retirement funds, and a trust fund manager. With the exception of the Ministry of Finance, Incorporated (MoF Inc.), the GLICs are major business groups with majority ownership of Malaysia’s leading publicly-listed companies, including the 35 SOEs in the top 100 listed firms. The GLICs directly hold about a quarter of Bursa Malaysia’s total market capitalisation. The total assets under the control of the seven GLICs amounted to RM 1.7 trillion (120% of GDP) in 2021 (Prime Minister’s Office, 2021[88]). The International Monetary Fund stated that, “the government has substantial de facto ownership in the financial sector: the seven GLICs have large interests in the main Malaysian financial and banking groups” (IMF, 2013[86]). In addition, “the GLICs are by far the most influential players in the Malaysian capital market” (IMF, 2013[86]). This situation is largely a reflection of the government agenda to encourage household savings and investment in the domestic economy and drive specific developmental agendas by the development financial institutions (DFIs).
The significant role of GLICs may discourage small firms from scaling up, as they may be acquired if they become large firms. GLICs have shown an appetite for taking over entrepreneurial companies, which may discourage private firms from working with SOEs. In 2021, the government announced principles to strengthen and optimise the overall structure and governance of GLICs. The 20 initiatives aim to achieve five key outcomes: i) sharpen clarity on the mandate of each GLIC; ii) spur new growth and enhanced socio-economic impact through developmental investments; iii) crowd-in the private sector while streamlining the role of the government and its agencies in business; iv) future-proof GLICs with best-in-class governance, capabilities, and strategies; and v) strengthen social protection safeguards and fiscal resilience (Ministry of Finance, 2021[87]). The selection process for the management and members of statutory boards should be based on performance indicators to assess qualifications (Chapter 1).
The largest GLIC is MoF Inc., which was established in 1957 to: i) stimulate economic growth by investing in strategic sectors; ii) attract local and foreign investors in specific areas such as biotechnology, information technology and communication; iii) fill in gaps where the private sector gives less investment priority, mainly due to substantial initial investment costs and high market barriers; and iv) provide services, such as public transport and utility services, to the public (Malaysian Institute of Chartered Secretaries and Administrators, 2021[89]).
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