Conceptualising Entrepreneurship, Innovation and Late Industrialisation: The State Creation of Entrepreneurs in Malaysia

138 Int. J. Management Concepts and Philosophy, Vol. 5, No. 2, 2011

Copyright © 2011 Inderscience Enterprises Ltd.

Conceptualising entrepreneurship, innovation and late industrialisation: the state creation of entrepreneurs in Malaysia

Jeff Tan Aga Khan University Institute for the Study of Muslim Civilisations (AKU-ISMC), 210 Euston Road, London NW1 2DA, UK E-mail: [email protected]

Abstract: Entrepreneurship is central to innovation and hence industrialisation. However, the innovation process is cumulative, increasingly undertaken within formal organisations, and characterised by uncertainty. The technological challenge facing developing country entrepreneurs attempting to ‘catch up’ is considerable in this context and can be supported by the appropriate institutions and policies. The efficacy of these will depend on the nature of the government – business relationship and whether the state can ensure such support is contingent upon learning taking place. Malaysia’s attempts to create domestic entrepreneurs demonstrate the difficulties involved, and the importance of accounting for political factors.

Keywords: entrepreneurship; innovation; learning; industrialisation; politics; Malaysia.

Reference to this paper should be made as follows: Tan, J. (2011) ‘Conceptualising entrepreneurship, innovation and late industrialisation: the state creation of entrepreneurs in Malaysia’, Int. J. Management Concepts and Philosophy, Vol. 5, No. 2, pp.138–158.

Biographical notes: Jeff Tan studied Economics in Sydney and London. He obtained his PhD in Economics at the School of Oriental and African Studies (SOAS). He taught development studies at SOAS and the London School of Economics (LSE) and is currently an Assistant Professor of Development Studies at the Aga Khan University Institute for the Study of Muslim Civilisations (AKU-ISMC) in London. He is the author of Privatization in Malaysia: Regulation, Rent-Seeking and Policy Failure (Routledge, 2008) and his most recent publication is ‘Infrastructure privatisation: oversold, misunderstood and inappropriate’ (Development Policy Review, 2011). His current research is on entrepreneurship, innovation and development.

1 Introduction

Much of the recent discussion of innovation and growth places entrepreneurship at the centre of the development process. However, entrepreneurship and innovation can only occur within the appropriate institutional context. The process of innovation is increasingly complex and undertaken within formal organisations. It is cumulative and based on learning, and is characterised by uncertainty. Furthermore, in the context of

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late industrialisation, developing countries face considerable entrepreneurial and technological gaps in relation to industrialised countries. This alters the process of innovation and creates significant challenges for domestic entrepreneurs attempting to ‘catch up’. Entrepreneurship here has less to do with new discoveries associated with innovation and is more about imitation and adaptation, as was the case with the East Asian late industrialisers (see, e.g., Chang, 1993; Hobday, 2000; Felker, 2003).

The process of late industrialisation entails policies to support, protect and nurture domestic entrepreneurship in order to facilitate learning and catching up. Here, the state will not only have to provide the necessary institutional support but also intervene directly to promote domestic entrepreneurial capacity necessary for learning to take place. The success of the state creation of entrepreneurship will then depend on whether policies to protect and nurture domestic industry and entrepreneurship lead to learning and technological catching up. This will in turn depend on the nature of the government-business relationship and, in particular, whether the government is able to withdraw any conditional support if learning targets are not met in order to ensure that any rents for learning are not wasted.

This will be largely circumscribed by the nature of social relations. Learning is less likely to occur where the withdrawal of state support is constrained by political factors. Moreover, because the state’s promotion of domestic entrepreneurs will also often be driven by political pressure from powerful groups contesting resources, this will further affect its ability to successfully manage rents. As we will see, this was the case in Malaysia where state attempts to create an indigenous entrepreneurial class resulted in a business class that remained uncompetitive and dependent on continued state patronage.

This paper examines the role of entrepreneurship in developing countries in the context of technological innovation and late industrialisation. We begin by identifying the entrepreneurial function most relevant to the process of dynamic change associated with industrialisation. Next, we examine the relationship between entrepreneurship and innovation by looking at what the process of innovation entails. We then locate the process of entrepreneurship and innovation in the context of late industrialisation and discuss why institutional and policy support will be needed to overcome technological and entrepreneurial gaps, and market and institutional failures. Finally, we examine Malaysia’s entrepreneurship and innovation policies in light of this framework.

2 The entrepreneurial function

Entrepreneurship theories have grappled with two key questions: Who is an entrepreneur? What does s/he do that makes him or her unique? There are conceptual difficulties here and little consensus as to how to answer such questions.

The entrepreneur has been associated with risk bearing (arising from uncertainty), innovation and ‘perception’ or ‘alertness’ in identifying profit opportunities. Following from this, the entrepreneur has been defined further as: someone who engages in exchanges for profit not unlike merchants and traders; a business leader; a manager, supervisor or organiser of production; and an owner, i.e., capitalist [see Hébert and Link, 1988; Naude, (2008), p.20]. The definition adopted in turn determines how entrepreneurial returns are viewed. Where the entrepreneur is defined mainly as a manager or organiser, then these returns represent a wage or rent of ability. Here, the entrepreneur is no more than a ‘superior labourer’ or highly skilled type of labour, or

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someone with superior business talent and differential ability who commands a rent as a premium for scarcity (see Kanbur, 1979; Hébert and Link, 1988; Henrekson, 2007).

Where risk is central to the definition, then returns to the entrepreneur are a risk premium. The emphasis of risk is associated with uncertainty arising from the lack of perfect foresight of the future and events beyond the entrepreneur’s control. The entrepreneur’s reward is thus a profit rather than wage because uncertainty cannot be measured. The introduction of uncertainty accounts for the emergence of the entrepreneur as functionally separate from capitalist (owner) (e.g., Knight, 1921). The distinction between entrepreneurship and capital use implies that capital will only give results if used productively, hence the importance of the entrepreneurial decision.

However, uncertainty can be reduced through contracts while decisions in the modern large corporation are not made by individuals but within the administrative structure of the firm. This raises questions about the concept of a unique class having primacy in undertaking the functions of risk taking and management (see Hébert and Link, 1988). More crucially, if the entrepreneur is empty handed and hence has nothing to lose, what does s/he risk? In other words, if all risk is borne by the capitalist, risk bearing is not an entrepreneurial activity, and the entrepreneurial reward is not a function of risk taking. There is clearly little agreement here, and the ultimate place of risk and uncertainty remains ambiguous, leaving profit theory in a kind of analytical limbo (Hébert and Link, 1988). Without a clear definition there is no distinct function for entrepreneurs and hence no need to analyse this group separately from merchants, traders, businessmen, capitalists or managers, whose functions are also all performed, at some point, by the entrepreneur.

Dynamic conceptions of the entrepreneur regard the entrepreneur as: the person who assumes the risk associated with uncertainty; an innovator; a decision maker; an industrial leader; an organiser and coordinator of economic resources; a contractor; an arbitrageur; and an allocator of resources among alternative uses. In short, dynamic entrepreneurship can involve arbitrage, speculative and innovative activity. Arbitrage constitutes a discovery of opportunity for pure gain and calls for no innovation, or in its pure form, no risk bearing and no capital since buying and selling are simultaneous. Speculation is an arbitrage across time. Innovation consists of an output, method of production, or organisation not previously in use [Kirzner, (1985), pp.84–85; see also Schumpeter, 1928, 1950]. However, since economic growth is about the dynamic change associated with technological advances, and has historically occurred as a result of industrialisation, the relevance of entrepreneurship in developing countries centres more on technological innovation in manufacturing.

3 Entrepreneurship and innovation

The relationship between entrepreneurship and innovation will depend on the role of entrepreneurs in the allocation of resources and what the process of innovation entails, particularly in the context of technological progress.

3.1 Entrepreneurship and resource allocation

In the major entrepreneurship theories, the market provides the price signals and incentives for entrepreneurial opportunities to be discovered. By seeking out these


opportunities, entrepreneurs become agents of change, expanding, transforming or restructuring the economy (see, e.g., Drucker, 1985; Schmitz, 1989). However, the problem facing entrepreneurship theories within the discipline of neoclassical economics is that no entrepreneurial function is required under the assumptions of equilibrium and perfect markets. In neoclassical economics, resource allocation takes place through the market, guided by prices. As the market is essentially an aggregate of individual preferences and decisions, there is no role for agency in the context of perfect markets, perfect information and certainty. Uncertainty (in the sense of the incalculable) has no meaning because solutions to economic problems require that the decisions can be calculated. In other words, true uncertainty (central to entrepreneurship theories) cannot be fully accommodated within the equilibrium tradition.

As prices convey all the necessary information, making the ‘correct’ decisions consists of the right mathematical calculation to ‘maximise’ some goal or utility function with the given available resources (Kirzner, 1985). Here, ordinary routine work, the repetition of orders, and operations can even be carried out by workers (see Schumpeter, 1950). In other words, ‘in a system of economic equilibrium the work of the entrepreneur cannot be quantitatively different from that of any other agent of production’ [Dobb, (1937), p.559, cited in Hébert and Link, (1988), p.101]. This leaves the issue of resource allocation – and thus growth – not properly resolved.

There are two approaches within entrepreneurship theories to show that entrepreneurs play a central role in economic activity while remaining within the general equilibrium framework. One is to reject equilibrium as the starting point and instead view disequilibrium as creating the ‘incentives required for discrepancies to be noticed and corrected’ (Kirzner, 1985; see also Schultz, 1975). The entrepreneurial function is then to respond to disequilibrium by reacting to opportunities that exist but have not yet been recognised or discovered, which then ‘fuels the tendency towards equilibrium’ [Kirzner, (1985), p.131]. The entrepreneur is motivated by profit opportunities and demonstrates a perceptiveness or alertness to them (Kihlstrom and Laffont, 1979; Gaglio and Katz, 2001; Licht, 2007). He or she is, therefore, responsible for the coordination that restores equilibrium position after some disturbance. This means that the entrepreneur is more of a gap seeker/filler and input completer – in other words, closer to an arbitrageur or speculator – rather than initiator of change (i.e., moving from one state of equilibrium to another within, and involving an overall increase in output).

In the second approach, the entrepreneur’s drive to innovate disrupts equilibrium, providing temporary monopoly gains that are soon wiped out by imitation, thereby necessitating further innovation (Schumpeter, 1950). This process of ‘creative destruction’ provides the link between entrepreneurship and innovation. In either case, the market through price signals is central to entrepreneurship theories with the logical policy emphasis on minimal state intervention to facilitate free markets.

3.2 The innovation process

The relationship between entrepreneurship and innovation is even less clear-cut because of the nature of the innovation process. Specifically, we can identify three features of innovation which may undermine the link between individual entrepreneurship and innovation.

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1 Formal organisation: The increasing complexity of R&D favours formal organisations, usually within integrated manufacturing firms, as opposed to individual innovators (see, e.g., Rosenberg, 1976, 1982). Furthermore, technological advances normally draw on some sub-set of publicly available knowledge (e.g., scientific and technical publications, and university research) (Dosi, 1988).

2 Learning: Significant innovations take place through ‘learning-by-doing’ and ‘learning-by-using’ (Rosenberg, 1976, 1982) and technological change within firms is often path-dependent (Nelson and Winter, 1982; Rosenberg, 1982).

3 Cumulative knowledge: Technological change is often cumulative (Nelson and Winter, 1982; Rosenberg, 1982; Dosi and Orsenigo, 1988) which means that what ‘the firm can hope to do technologically in the future is constrained by what it has been capable of doing in the past’ [Dosi, (1988), p.225].

The conception of entrepreneurship as essentially an individual activity stems from the belief that knowledge is always deposited in individuals. This ignores the fact that, at least in modern economies, institutions and organisations are also depositories of knowledge, suggesting that the old concept of entrepreneurship based entirely on individuals may no longer be valid (see Chang and Kozul-Wright, 1994). One way around this is by conceiving the entrepreneur as an organisation comprising all the people required to perform the entrepreneurial functions [Harbison, 1956; see also Selby, (1981), p.16]. Thus, in a large corporation where it may be difficult to identify the entrepreneurial role, the concept of organisation rather than that of the entrepreneur in the analysis of the functions of coordination, planning, innovation, and risk bearing may be more useful. However, the concept of firm as entrepreneur does not sit well with entrepreneurship theories because it undermines the methodological individualism on which entrepreneurship theories tend to be built (see, e.g., Hébert and Link, 1988).

4 Late industrialisation

Late industrialisation presents additional challenges for the analysis and practice of entrepreneurship and innovation because of the presence of technological and entrepreneurial gaps, and market and institutional failures.

4.1 Technological gaps

Developing countries are characterised by low levels of technology and hence efficiency, particularly in relation to incumbent firms in advanced countries. There is also a very large stock of proven technical innovations in advanced economies which have not yet been applied in developing countries. As a result, the nature of the entrepreneur’s function in developing countries today differs considerably from that in 19th century Europe and USA [Kilby, (1971), pp.4–5]. There is less of a role for original innovation as there is for imitation and adaptation because technology can be imported.

The critical entrepreneurial function in developing countries in this context is to obtain adequate financing, adapt techniques and organisation, maximise factor productivities, minimise unit costs, and improvise substitutes for non-available skills and materials. However, developing country entrepreneurs also face operational problems of


matching advanced technology with qualitatively ill-fitting local factors of production that are considerably greater. Moreover, the upgrading of factor inputs necessary to introduce modern techniques of production is many times greater and must occur in a far shorter interval than previously with advanced countries (Kilby, 1971).

4.2 Entrepreneurial gap

This brings us to the entrepreneurial gap – the lack of entrepreneurial capacity in terms of depth (skills, experience) and breadth (supply). Figure 1 identifies four main entrepreneurial functions (Kilby, 1971; Nafziger, 1986):

Figure 1 Typology of entrepreneurial functions

I. Exchange relationships 1. Perception of market opportunities (novel or imitative) 2. Gaining command over scarce resources 3. Purchasing inputs 4. Marketing and responding to competition II. Political administration 1. Dealing with bureaucracy (concessions, licenses, taxes) 2. Management of human relations within the firm 3. Management of customer and supplier relations III. Management control 1. Financial management 2. Production management (control by written records, supervision,

coordinating input flow with orders, maintenance) IV. Technology 1. Acquiring and overseeing assembly of the factory 2. Industrial engineering (minimising inputs with a given production process) 3. Upgrading processes and product quality 4. Introduction of new production techniques and products

Technically, the entrepreneur (or entrepreneurial team) will (be able to) only perform activities I.1 and I.2 (and possibly I.3 and I.4), the skills of the remaining functions being available in the market place (Kilby, 1971). In the case of developing countries, the short supply of people with these skills usually means that the entrepreneur will have to perform all these tasks (Nafziger, 1986).

The shortage of entrepreneurial capacity means that people with ‘technical, executive and organisational skills may be too scarce in less developed countries to use in developing new combinations in the Schumpeterian sense’ (Nafziger, 1986). More tasks will have to be performed by developing country entrepreneurs who at the same time lack the capacities to undertake these additional tasks. Entrepreneurial weakness in technology and production management was long ago identified as a major bottleneck to indigenous industrial development (see, e.g., Kilby, 1971; Selby, 1981). This is then exacerbated by the absence of a risk-taking entrepreneurial class in the first place because of market and institutional failures.

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4.3 Market and institutional failures

Developing countries are characterised by missing markets, impeded factor mobility, lumpiness and unavailable inputs (see, e.g., Galbraith, 1956; Comanor, 1967; Kilby, 1971). Imperfect information and bounded rationality lead to uncertainty in the formation of expectations and decisions, as well as non-maximisation behaviour. Furthermore, it may not be efficient to apply maximisation procedures in environments characterised by complexity and uncertainty (Dosi and Orsenigo, 1988). Private investments in technological innovation confront further market failures related to imperfect information, high and highly variable risk, large fixed costs and economies of scale, non-exclusivity (competitors benefit by copying) and positive externalities (Felker, 1998).

Incomplete knowledge and complex motivations give rise to ‘strategic uncertainty’ and coordination failures where complimentary investments needed for economic transformation fail to take place, especially where sectional interests dominate over concerns for the whole economy (see Chang and Kozul-Wright, 1994; Chang and Rowthorn, 1995). The high costs of capital investment and shallow capital markets compound the very high risks inherent in moving into manufacturing and potentially deter (especially risk averse) entrepreneurs. In other words, there are few incentives for developing country entrepreneurs to invest in manufacturing, and indeed there is every reason not to given the initial lack of competitiveness and existence of less risky investment alternatives with better returns in the short term. These market failures provide the standard rationales for state intervention.

5 Institutional and policy support

Institutional and policy support will be needed to address problems of information asymmetry, missing markets and the absence of a risk-taking entrepreneurial class, and where there are positive technological externalities. Public institutions and policies can help promote entrepreneurship and innovation by shaping behaviour (through the development of organisations, rules, beliefs, etc) and organising the interactions and coordination between agents with imperfect information and hence approximate knowledge of possible outcomes (Dosi and Orsenigo, 1988). Coordination principles or rules based on rational structures and rational procedures (rather than rational choice) can promote the growth of knowledge (Chang and Rowthorn, 1995). The institutionalisation of research and development can accelerate this process because innovative activities are often facilitated by collective effort (Dosi and Orsenigo, 1988) and undertaken within ‘national innovation systems’ – the variety of public and private institutions which affect technological change (see, e.g., Nelson, 1993).

Related to this is the concept of ‘national systems of entrepreneurship’ – ‘the kinds of institutional arrangements supporting continuous innovation through a network of public and private institutional linkages that encourage risk-taking, learning, imitating and experimenting’ [Chang and Kozul-Wright, (1994), pp.864–865]. Entrepreneurship here can be located in the interaction of activities inside the firm, between users and producers of a product, between firms and other economic institutions and in the interaction of economic and non-economic institutions (e.g., universities and government agencies).


More than simple coordination, however, the state can provide a coherent vision of the future economy at an early stage of the transformation and drive private sector agents into a concerted action without making them spend excessive resources in information gathering and processing, political bargaining and so on (Chang and Rowthorn, 1995). Institutions can reduce uncertainty, regulate conflict and establish linkages to ensure the flow of knowledge and capabilities between economic units. The state can underwrite the high cost of information about technology and provide incentives for innovation (i.e., Schumpeterian rents) (see, e.g., Rodrik, 2004). It can also address the problems of coordination failure by ‘calling forth and enlisting for development purposes, resources and abilities that are hidden, scattered or badly utilised’ [Hirschman, (1987), p.210].

The success of entrepreneurship policies will be closely related to the state’s capacity to manage the development process. Entrepreneurship here will be tied to the emergence of a capitalist class. This is because the development process has historically involved the transfer of productive resources from one group to another. Further economic development has also historically been characterised by structural change associated with industrialisation and reflected in the growth of industry’s share of GDP. Development therefore hinges on the transfer of resources to a class of capitalists engaged in manufacturing.

In developing countries, there may be no pre-existing entrepreneurs, especially at the early stages of development, and critical investments in manufacturing necessary for industrialisation may not be undertaken. In this context, the state may have to undertake such investments itself, and/or promote the development of domestic entrepreneurship to (eventually) do this. These two processes are often connected; the state can facilitate capital formation by later transferring state owned enterprises (SOEs) to emerging or potential entrepreneurs through privatisation. Here, entrepreneurship will often be closely linked with the ownership of assets. That is to say, the state will be attempting to create an indigenous capitalist class to engage in entrepreneurship and undertake investments and technological acquisition in manufacturing. However, as capital formation also depends on technological innovation, successful entrepreneurship will depend on subsidies for learning because the existing level of knowledge and productivity of emerging or potential entrepreneurs cannot, by definition, be very high to begin with. This means that in addition to the transfer of assets (e.g., privatisation), the state will also need to subsidise learning. This will usually involve some form of infant industry protection to provide the opportunity of learning-by-doing (see Arrow, 1962).

The transfer of productive resources and subsidies for learning will be inherently political and thus keenly contested. In this context, the emergence or otherwise of a successful domestic entrepreneurial class will depend on the capacity of the state to manage these two processes. Learning will depend on industry’s ‘collective learning’ ability and ‘knowledge accumulation’ (Jacobsson, 1993; Bruton, 1998; Kim, 2004), along with the state’s institutional capacity to design appropriate incentives. This may involve the provision of subsidies conditional on (export) performance targets which in turn entails an underlying enforcement capacity to ensure that these subsidies lead to learning and not long-term inefficiency. This state capacity is in turn affected by the nature of social relations and balance of political forces specific to a country.

In the late industrialisation of South Korea and Taiwan, the state’s relationship was with productive segments of society, namely industrial capital, in part because of the earlier Japanese colonial emphasis on manufacturing. More crucially, effective state intervention was possible because of the absence of powerful groups in society which

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allowed the state to enforce decisions by penalising poor performers and rewarding good performers. In contrast, most developing countries typically have powerful factions, often led by unproductive social groups who can, for a price, protect inefficient enterprises. These countries also have a far more limited pool of qualified candidates to select from and impose discipline on through the threat of replacement. These conditions can effectively constrain the state’s ability to transform those initially selected into efficient capitalists through the effective management of rents.

State capacity thus does not only depend on the state’s reach (its connections with capitalist groups or other productive relationships) but also its ability to overcome political constraints (i.e., resistance to discipline). Hence, while the South Korean state could enforce discipline by ensuring compliance with productivity maximisation, many developing country states are faced with the problem of incompetent (non-capitalist) candidates who are also harder to discipline. The political capacity of South Korea and Taiwan to withdraw state support when performance targets were not met can be traced back to the particular sets of social relations in each country.

6 Malaysia’s entrepreneurship and innovation policies

Malaysia provides a useful case study because of state efforts to promote entrepreneurship and innovation through the transfer of productive resources and creation of learning rents. The outcome of these policies can in turn be traced back to a specific set of social relations that constrained state capacity. We can identify two broad phases of entrepreneurship and innovation policies in Malaysia, from 1970 to the early 1980s under the New Economic Policy, and from 1983–2000 during the privatisation programme. Both sets of policies involved the transfer of resources and sought to promote technology acquisition with the specific aim of creating a Bumiputera [Malay] Commercial and Industrial Community (BCIC), and to address issues of absorbing complex organisational and production processes necessary for technological upgrading and industry linkages.

6.1 New Economic Policy

The New Economic Policy was introduced in 1970 in response to pressure for greater government intervention from the emerging Malay middle class in general, and Malay businessmen specifically (see, e.g., Neuman, 1971; Puthucheary, 1984; Lim, 1985; Ho, 1988; Jesudason, 1989). The thrust of the New Economic Policy was largely shaped by these demands and involved the redistribution of wealth to this class through substantial increases in education, (public) employment and business opportunities, and the ownership of corporate equity with the aim of creating a BCIC. By 1985, the government had created around 700 SOEs that were engaged in a variety of economic activity and provided entrepreneurial training for Malays, while the state acquisition of well-managed, profitable companies increased de facto Malay corporate ownership and provided further management opportunities. These measures were facilitated by the 1975 Industrial Coordination Act (ICA) which required that companies set aside 30% of shares issued for Malay equity, with (below market) share prices set by the Capital Issues Committee (CIC) for Malay individuals and SOEs. Efforts to promote a Malay industrial capitalist class were thus closely linked with industrial policy and need to be considered together.


As the British colonial authorities discouraged local industries in Malaysia, confining these to processing raw materials for export and some domestic consumption (Jomo, 1994), early industrial policies (late 1950s to mid 1960s) sought to expand the domestic manufacturing base through import substituting industrialisation (ISI) by identifying new products and processes to promote learning-by-doing (see Jomo, 1993; Ali, 1994).The New Economic Policy coincided with a shift in industrial policy from ISI to export-oriented industrialisation (EOI), prompted by the inherent limitations of ISI in a small, open capitalist economy (see Jomo, 1994). EOI was spearheaded by the Federal Industrial Development Authority (FIDA) and supported by the 1968 Investment Incentives Act (IIA) to encourage diversification and manufactured exports through various tax incentives and the 1971 FTZ Act to promote free trade zones (see Jomo and Edwards, 1993; Rasiah, 1996). The Malaysian Industrial Development Authority (MIDA) worked with state government corporations to attract foreign investment with the main emphasis on labour-intensive manufacturing in export processing or free trade zones [Malaysia, (1969), p.6, cited in Rasiah, (1996), p.191].

The government sought to promote technology acquisition (mainly through technology transfer and licensing agreements) under the Ministry of International Trade and Industry (MITI) and the Ministry of Science, Technology and Environment (MOSTE) (see Ali, 1994). MITI overlooked technology acquisition through its Technology Transfer Unit (TTU), MIDA and the Industrial Master Plan (IMP) Sectoral Task Force. The TTU approved technology transfer agreements to safeguard the ‘national interest’, prevent unfair restrictions on Malaysian firms, and ensure fees were reasonable and technology transfer was meaningful (Ali, 1993, 1996). MIDA evaluated industrial projects and the IMP Sectoral Task Force reviewed priority products and industries according to IMP priorities (Ali, 1994).

MOSTE facilitated technology transfer by: providing linkages between technology acquisition and industrial development (through the Standards and Industrial Research Institute of Malaysia – Technology Transfer Centre); assisting entrepreneurs with information on technology selection and acquisition (Malaysian Science and Technology Information Centre); formulating science and technology policies and R&D priorities (National Council for Scientific Research and Development); identifying priority sectors, formulating technology transfer plans and policies, and ensuring the growth of the industrial sector (Coordinating Council for Industrial Technology Transfer); and promoting the development of technology parks and selected industries, products and technologies (the Science Advisor to the Prime Minister) (Ali, 1994). Public sector agencies were supported by policies to promote technology acquisition, including the Intensification of Research Priority Areas programme (1986) and the Action Plan for Industrial Technology Development (1990) along with tax incentives and research grants for small and medium size industries (SMIs) (Ali, 1994; Rasiah, 2001).

Malaysia’s manufacturing growth was impressive. As a result of EOI, the GDP share of manufacturing grew from 13.1% in 1970 to 20% by 1985, while the manufacturing share of exports grew from 11.9% to 33% in the same period (Jomo, 1994; Mohamed, 1994). Furthermore, Malaysia’s manufactured exports were based on high-skill and technologically complex products (as opposed to garments for example), with EOI dominated by electronics and electrical goods which increased from 8.5% of manufactured exports in 1970 to 47.7% by 1980 (Mohamed, 1994). Between 1971 and 1990, manufactured exports grew at a rate of 24% per annum, enabling Malaysia to become the world’s largest exporter of semiconductors and among the largest exporters

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of disk drives, telecommunications apparatus, audio equipment, room air-conditioners, calculators, colour televisions and various household and electrical appliances (Lall, 1995).

However, the rapid growth of manufacturing and manufactured exports relied heavily on foreign direct investment (FDI), with EOI dominated by the subsidiaries, affiliates or licensees of multinational companies. This was in part shaped by New Economic Policy considerations to bypass Malaysian Chinese capital though arguably also because of limited existing domestic production capabilities and the preference of Chinese capital for commercial over industrial investments (see, e.g., Lubeck, 1992; Henderson and Applebaum, 1992; Jomo, 1993, 2001c). The reliance on foreign investment had several consequences for Malaysia’s industrial structure in terms of depth and domestic technological capabilities. First, the foreign domination of almost all internationally competitive non-resource-based industrial capability restricted domestic firms mainly to assembly and subcontracting as original equipment manufacturer (OEM) (Jomo, 2001b; Ghazali, 1994; Ali and Wong, 1993; Lall, 1995). Local firms generally demonstrated a minimum technological dynamism and most of the domestic industrial sector remained technologically passive, with few intra- and inter-industry linkages, and little diversification into the export market (Felker, 1998, 1999; Rasiah and Shari, 2001).

Second, the export base remained narrow. The 1986 Industrial Master Plan (IMP) [cited in Jomo, (1994), p.120] highlighted the heavy dependence on components production for export, in particular semiconductors, with consumer and industrial electronics only contributing 15% to 20% of total output (compared to 55% to 70% in South Korea and Taiwan). Third, manufactured exports had a high import content, indicating a fairly shallow industrialisation process (see, e.g., Jomo and Edwards, 1993; Jomo, 1994). The share of intermediate goods in total imports for example rose from 35% in 1970 to 47% in 1985, with the share of imported inputs in the gross export value of manufactured exports as high as 75% (Mohamed, 1994; Aslam and Jomo, 2001).

Fourth, low local content, especially in electronics, meant that there were limited linkages and technology transfer between the foreign-dominated manufacturing export sector and domestic firms outside the free trade zones (Jomo and Edwards, 1993; Mohamed, 1994; Ali, 1994). Despite the increasing number of technology transfer agreements (mainly in electronics and electrical, chemical, and fabricated metal industries) and the relative size and sophistication of Malaysia’s manufacturing sector and export profile, the local technological base remained shallow with excessive dependence on technology, marketing, management and components supply (Ali, 1993, 1994; Felker, 1999). This also meant that there was an outflow of royalty payments, fees and other charges for technology use, with little net foreign exchange savings [MIDA, 1986, cited in Jomo, (1994), p.121].

Poor progress in technology acquisition has generally been blamed on institutional (bureaucratic) failures and industry’s lack of capacity to learn (see, e.g., Ali, 1994; Felker, 1998). Here, MITI lacked the ‘assessment capability’ (i.e., experience and expertise) to evaluate technology content and thus ensure the real transfer of technology (Ali, 1994). The National Council for Scientific Research and Development and MOSTE had little political and financial clout to influence the broader range of trade and industry policies affecting technological development and institutional arrangements to promote technology acquisition also suffered serious coordination failures (see, e.g., Felker, 1998; Rasiah, 2001).


Failure was also due to the complex nature of the technology and lack of (Malay) skills. The capacity to learn is said to depend on industry’s ‘collective learning’ ability (facilitated by the country’s human capital and competitive pressures from exporting) and ‘knowledge accumulation’ (e.g., on-the-job learning and ‘learning by doing’ and ‘using’, in order to learn how to produce before learning how to export) (Bell et al., 1984; Jacobsson, 1993; Bruton, 1998; Kim, 2004). Malaysia’s low skill endowments reflected weaknesses in the education system that restricted innovation (see, e.g., Jomo, 1993, 2001c). Little attention was given to viability and managerial competence, with state agencies not interested in building up an indigenous technological capacity, preferring easy access to foreign partners and technology (Jesudason, 1989). As a result, Malaysian firms had limited capabilities to choose and assimilate imported technologies, especially in the context of imperfect information (Ali, 1994). The failure to learn can also be traced back to an efficiency trade-off under the New Economic Policy arising from the political (and ethnic) imperative to develop (Malay) entrepreneurs through the quick transfer of assets to state agencies (see, e.g., Jomo and Hamilton-Hart, 2001).

The government sought to create Malay capitalists through ownership and management, supported by preferential treatment. However, there were no performance targets or conditionalities, while insulation from market competition along with easy access to finance undermined business discipline and learning-by-doing (Jesudason, 1989; Gomez and Jomo, 1997). There was little pressure for infant industries to grow up, with concerns raised in two Malaysia Plans regarding the efficiency losses due to protection, and again in 1983 by the Malaysian Industrial Policy Study which recommended the halving of average levels of protection (Jomo and Edwards, 1993; Alavi, 1998; Rasiah and Shari, 2001). Despite this, inefficient import-substituting industries continued to receive high (and even increasing) levels of protection without proper evaluation, monitoring or performance conditions, and irrespective of productive capabilities, allowing unsuccessful firms to waste rents (Bruton, 1992; Alavi, 1996, 1998; Jomo and Tan, 1999; Rasiah, 2001; Rasiah and Shari, 2001). As a result, the New Economic Policy did not increase business acumen or produce a class of dynamic Malay entrepreneurs (Gale, 1981; Jesudason, 1989; Bowie, 1991; Kamal, 1989; Khoo, 1995; Crouch, 1996; Gomez and Jomo, 1997). Overexpansion of the public sector under the New Economic Policy also created a small but powerful ‘bureaucratic-capitalist elite’ able to largely resist government attempts to impose budgetary discipline, making policy adjustments increasingly difficult (Jomo, 1986; Mehmet, 1988; Bowie, 1991; Bruton, 1992; Jomo and Tan, 1999).

This led to public and private sector inefficiency and a lack of productive base, reflected in the divestment for quick profits and a preference for investments in protected or non-tradable sectors which contributed least towards independent industrialisation, namely services, property development and construction (see, e.g., Ali, 1994). The accelerated expansion of construction and services at a time when Malaysian manufacturing was still dominated by low value added OEM activities undermined technological deepening (Rasiah, 2001; Ghazali, 1994). The preference for investment outside of manufacturing was reinforced by the industrial finance and banking systems. Unlike South Korea, Malaysia’s industrial finance system was weak in design and execution, in part because of the dominance of foreign firms in large-scale manufacturing and Chinese firms in SMIs (see, e.g., Jomo and Hamilton-Hart, 2001). Furthermore, banks in Malaysia were based on the Anglo-American model, acting as passive intermediaries and lending tended to be conservative and based on collateral rather than

150 J. Tan

project viability, with a preference for general commerce at the expense of manufacturing (Chin and Jomo, 2001). Loans to manufacturing rose from the 1970s but only modestly compared to the increasing share of loans for property, stocks and shares, again reflecting lending preferences [Chin and Jomo, (2001), p.98]. The lack of incentives for Malaysian banks to favour long-term lending reflected weaknesses in financial policy and is seen to have limited the development of (non-resource-based) domestic manufacturing (Chin and Jomo, 2001).

6.2 Privatisation

Privatisation was introduced in 1983, in part to address New Economic Policy inefficiencies, and coincided with several policy and institutional changes. These included a second round of ISI from the mid 1980s; the replacement of the New Economic Policy with the New Development Policy to provide ‘a more coherent and systematic analysis of the needs and capabilities of manufacturing activities’ [Lall, (1995), p.767]; and the centralisation of policy making in the Economic Planning Unit (EPU) in the Prime Minister’s Department. The government also attempted to recreate Japan’s institutionalised state-business relationships with the ‘Look East’ policy in 1981 that sought to raise productivity and competitiveness by instilling Japanese attitudes and work habits (Bruton, 1992). This was followed by ‘Malaysia Incorporated’ in 1983 which aimed to foster private-public cooperation and consultation for industrial upgrading (Lall, 1995; Felker, 1998). The institutionalising of direct, high-level, public-private networks aimed to free policymaking and the industrialisation project from the distributional constraints and inefficiencies of the New Economic Policy by centralising decision-making and rent allocation more narrowly among a smaller group of entrepreneurs through the management of key government-linked projects (Felker, 1998).

The state-owned Heavy Industries Corporation (HICOM) sought to address the issue of absorbing complex organisational and production processes necessary for technological upgrading and industry linkages (Jomo and Edwards, 1993; Jomo, 1994; Lall, 1995). State-led industrialisation was seen as necessary because Malaysia, unlike South Korea, did not have large industrial conglomerates or many (non-resource-based) major manufacturers with strong records of international competitiveness to undertake industrial upgrading (Jomo and Tan, 1999; Lall, 1995). The creation of HICOM – encompassing steel, cement and automobile production – and its subsequent privatisation was an attempt to develop large Malaysian conglomerates along the lines of South Korea’s chaebol and Japan’s zaibatsu. The subsequent transfer of these SOEs to a select group of emerging (Malay) entrepreneurs through the privatisation programme represented the government’s attempts at creating a domestic capitalist class that began under the New Economic Policy.

In terms of innovation policies, the government sought to shift into higher technology sectors through the Malaysian Industry-Government Group for High Technology (MIGHT) (a government-business technology forum, formed in 1993 to track emerging technologies and encourage ventures exploiting new technological innovations), the Intensification of Research Priority Areas programme (to provide a conceptual view of technology development), Technology Action Plan, Malaysian Technology Development Corporation (MTDC), Advanced Manufacturing Technology Centre, Malaysian Institute for Microelectronics Systems (MIMOS) and Technology Park Malaysia (Felker, 1998). It also launched a second round of FDI-led EOI in the second half of the 1980s through the


1986 Promotion of Investment Act that provided generous incentives and relaxed some New Economic Policy ethnic requirements but added technological and domestic content conditions (Lall, 1995; Rasiah and Shari, 2001). This led to a new round of FDI, mainly from NICs and Japan, facilitated by a strengthening Japanese yen.

Despite these interventions, Malaysia’s industrialisation remained largely ‘technology-less’, without real technological strength or capacity in product development or capital goods production, and with no internationally recognisable brands (Ghazali, 1994; Ali and Wong, 1993; Jomo, 2001b). Malaysia’s industrialisation continued to be characterised by:

1 a very high degree of concentration – the top five products accounted for 58.9% of total exports in 1990 with electronics accounting for 67.5% of manufactured exports in 1995 and 68.2% of total export value in 1998

2 foreign domination – foreign firms accounted for over 70% of the total value of manufactured exports in the early 1990s and 91% of electronics by 1993

3 low levels of local content (and high import content) with weak linkages

4 relatively low technological capabilities restricted to assembly and finishing operations, with few high value added and technologically demanding tasks (as even subsidiaries of multinational companies undertook no design functions, sourcing other product technology from parent companies or major buyers)

5 the absence of independent marketing capabilities necessary to upgrade into higher value added products and markets [Lall, (1995), pp.769–770; Jomo, 2001b].

The inability to address industrial deepening and technology acquisition meant that Malaysia’s industrialisation remained vulnerable to changes in FDI flows to countries with lower wage costs, higher skill endowments and engineering capabilities, and larger domestic markets such as India and China (see, e.g., Lall, 1995). Failing to improve competitiveness and moving into higher technological sectors, Malaysian firms continued to rely on state subsidies and protection, and shifted into non-tradable sectors. Malays in particular remained restricted to property, construction and finance, and dependent on government contracts, continued state support and intervention. This was reflected in the sectoral distribution of privatisation that reflected the ongoing preference of Malay businessmen for these sectors (see Tan, 2008). More tellingly, privatisation was characterised by the state restructuring, bail-outs and takeovers of companies owned by the small group of Malay businessmen who received the bulk of privatisation, with significant dilutions of Malay interests in privatised enterprises overall (Malaysia, 1996, 2001). A prominent example was HICOM (which included the national car project Proton) which was renationalised following insufficient technological progress, and its private owner subsequently moving into largely protected, non-tradable sectors (see Tan, 2008).

These problems can be largely attributed to institutional failure. As heavy industries were set up to serve domestic rather than export markets, there was no systematic attempt to guide or monitor the technology development process, with the sector characterised by soft budgets and the lack of performance targets and conditionalities (Lall, 1995). Selective state intervention was of a much poorer quality and considerably less effective than in Taiwan and South Korea in the 1960s and 1970s, with industrial policy characterised by very high protection rates and little evidence of rent deployment

152 J. Tan

favouring industrialisation or productive use (Jomo and Tan, 1999). Instead, rents provided the wrong incentives, even encouraging previously efficient companies into protected sectors (see, e.g., Alavi, 1998). Not surprisingly, lower protection levels following liberalisation from the mid 1980s pushed private interests into other rentier activities such as property and share purchases, with construction and real estate growing significantly faster than GDP (Rasiah, 2001; Jomo, 2001a).

Underlying these institutional failures were changes in social relations that affected the state’s capacity to address the three conditions necessary for late industrialisation, namely the transfer of resources to productive groups, management of conflict arising from potential challenges by losers, and promotion of learning. Under the New Economic Policy, the government was able to centralise redistribution without state capture due to a unified party elite under a strong leadership which had the support of a large middle class and rural populace (as a result of bureaucratic expansion and rural development) [Leong, 1991, cited in Felker, (1998), p.90]. This centralised patronage allowed UMNO, the ruling Malay party, to control resources, providing benefits to its supporters and strengthening party loyalty (Jesudason, 1989; Crouch, 1993; Khoo, 1992; Felker, 1998). The government was also able to strengthen and insulate the state’s planning and economic agencies, with bureaucrats controlling resources through the management of state assets, and initially with minimal private business influence on economic policies [Felker, 1998; Leong, 1991, cited in Felker, (1998), p.90].

However, overexpansion of the public sector also created a small but powerful ‘bureaucratic-capitalist elite’ able to largely resist government attempts to impose budgetary discipline, making policy adjustments increasingly difficult (Jomo, 1986; Mehmet, 1988; Bowie, 1991; Bruton, 1992; Jomo and Tan, 1999). More crucially, despite its continued dependence on the state, the Malay business class grew in organisation and influence (Jesudason, 1989), with the growing number of Malay businessmen fostered by the New Economic Policy becoming an increasingly important element in the Malay political elite by the 1980s. This was reflected in the changing composition of UMNO leaders from politicians and ‘administocrats’ to a combination of politicians and businessmen (Leigh, 1992), with significantly more Malay politicians active as businessmen (on their own and on UMNO’s behalf) and Malay businessmen active in politics after the New Economic Policy (Ho, 1988). State efforts to control the ‘commanding heights of the economy’ (e.g., plantations and tin mines) also produced a powerful group of former state managers increasingly active in business (Jesudason, 1989).

The late 1970s saw the emergence and transformation of the Malay bourgeoisie from primarily directors – not owners – of large corporations (before the mid-1970s) to Malay millionaires (Lim, 1985), with professional and trustee Malay executive directors becoming prominent by the late 1980s (Searle, 1999). This paralleled changes in the occupational background and outlook of UMNO leaders and grassroots members, with school teachers and other local leaders replaced by businessmen and university-educated professionals produced by the New Economic Policy (Crouch, 1993; Searle, 1999). ‘Middle class elements’ were able to completely take over UMNO by the early 1980s (Jomo, 1999), and by the time privatisation was introduced, there was already a large Malay middle class, including a younger, more professionally trained managerial cadre whose support was important and who had to be accommodated (see, e.g., Milne and Mauzy, 1999).


The changing composition of the Malay middle class reshaped the internal politics within UMNO local branches. Increasing economic patronage changed the nature of the patron-client relationships, transforming local UMNO representatives into political patrons. Elected members of parliament who were previously political patrons (providing political support in return for economic benefits) greatly increased their control of the district development machinery, allowing them to distribute development benefits and purchase continued support (Shamsul, 1986). While Malay businessmen were heavily dependent on their access to government patronage, they became an important force in the internal politics of UMNO through the party’s extensive patronage network (Khoo, 1992; Crouch, 1993; Ahmad, 1997), increasing factional struggles for nomination and outbreaks of violence at UMNO branch and division meetings after 1984 (Shamsul, 1986). Although factions were already present in all levels of UMNO (Hussain, 1985), the rise of ‘money politics’ was closely related to (if not a direct result of) the New Economic Policy (Shamsul, 1986). This resulted in a series of bitter contests between 1981 and 1987, culminating in the leadership challenge and open party split in 1987 (Khoo, 1992; Crouch, 1993).

These changes in social relations help explain the seemingly dramatic policy shift from direct state intervention under the New Economic Policy to privatisation (and the accompanying shift from EOI to ISI). While this shift was in part motivated by economic considerations related to policy inefficiencies, it was largely politically driven by social changes related to the growth of, and subsequent differentiation within the Malay middle class under the New Economic Policy. In particular, was the emergence of an influential group of Malay businessmen linked to key institutions and closely associated with key political leaders in UMNO, and whose support enabled Prime Minister Mahathir Mohamad to centralise authority and introduce privatisation (Leigh, 1992; Felker, 1998). Privatisation was thus an extension of the New Economic Policy and part of ongoing state policies to create Malay capitalists through the transfer of resources, this time favouring an emerging group of big businessmen that stood to benefit from the sale of state assets at the expense of those who continued to rely on New Economic Policy-style assistance and hand-outs.

However, this process remained constrained by the lack of domestic entrepreneurial capacity and preference for non-productive sectors as opposed to manufacturing, with privatisation focussing largely on sectors where Malay enterprises were most concentrated, namely in ‘construction’ (the largest privatised sector), ‘government services’, and ‘wholesale and retail trade, hotels and restaurants’, and primarily benefited the emerging group of Malay businessmen closely associated with the key political leaders in UMNO (Gomez, 2002; Tan, 2008). More crucially, the state’s capacity to create a dynamic industrial capitalist class was constrained by the growing political contestation and factionalisation within the party that led to increasingly personalised patron-client relationships. This compromised policy choice and undermined the political leadership’s ability and/or willingness to discipline those whose support it relied on (see Tan, 2008). State capacity to direct domestic capital into strategic manufacturing industries and to ensure that efficiency gains through learning took place was thus constrained by the nature of social relations in Malaysia. This in turn adversely affected industrialisation, preventing the emergence of an efficient, ‘deepening’ industrial policy.

154 J. Tan

7 Conclusions

Developing country entrepreneurs face considerable challenges related to innovation and late industrialisation. The state can play a central role to promote entrepreneurship and learning necessary for technological acquisition and catching up. Success will depend on a variety of institutional factors which are in turn shaped by political factors specific to each country that affect the state’s capacity to manage the learning process. Malaysia’s efforts to develop a domestic entrepreneurial class to address issues of absorbing complex organisational and production processes necessary for technological upgrading and industrial linkages illustrates the sorts of political constraints to the effective management of learning rents.

The absence of an established industrial capitalist class and the political demands from a Malay middle and business class meant that the transfer of resources was not necessarily to productive groups. Demands by the Malay middle class coincided with wider Malay dissatisfaction with growing inter-ethnic inequality. The New Economic Policy aimed to create a Malay industrial capitalist class through preferential treatment but failed to promote learning or technological catching up because subsidies and protection were not conditional on performance. Furthermore, a reliance on FDI (to bypass Chinese capital) weakened domestic industrial and technological capacity. The government sought to address these problems and at the same time transfer resources to an emerging group of large Malay capitalists through privatisation and a second round of state-led ISI based on heavy industries.

However, this process was also politically driven by the differentiation within the Malay middle class that altered the balance of power in the ruling Malay party. Privatisation here represented a change in the way resources were allocated. This was in part driven by intra-party factional struggles, supported by an emerging group of big businessmen that stood to benefit from the sale of state assets at the expense of those who continued to rely on New Economic Policy-style assistance and hand-outs. In this case, the capacity of the state to manage the transfer of resources in order to create a domestic capitalist class, and to promote learning necessary for entrepreneurship and innovation, was constrained by the growing competition, conflict and factionalisation that led to increasingly personalised patron-client relationships which made it difficult for the political leadership to discipline those whose support it relied on.

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Conceptualising Entrepreneurship, Innovation and Late Industrialisation: The State Creation of Entrepreneurs in Malaysia

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