Mahathir’s Economic Legacy

Jomo K.S.

When analysts evaluate Dr. Mahathir Mohamad’s 22-year impact on Malaysia’s economic development, they would do well to avoid two very different positions.

 The more common position, which the domestic media regularly promotes, uncritically praises Mahathir as a legendary leader of exceptional vision who has single-handedly transformed, modernized, industrialized, and strengthened the national economy. The opposite position, most obviously adopted by many domestic and foreign critics during the 1985-86 and 1997-98 recessions, cast Mahathir as an oddball of doubtful sanity who only sought to remain in power to protect the interests of his family and closest associates.

 Neither position is tenable.

 Mahathir had his ambitions, initiatives, and plans, and launched his favored projects with flourishes of economic nationalism. Yet many of those pet projects entailed huge problems, flaws, and abuses. Moreover, Mahathir’s policies were inconsistent, and several of his major policy turns were in fact “U-turns” made in response to crises, some of which were created by him, albeit unwittingly.

 Hence, Mahathir’s interventions in the economy were neither uniformly impressive nor simply whimsical. It would be fairer to say that Mahathir leaves behind him a checkered record of bold experiments, false starts, partial successes, and narrow escapes. This may be gleaned from an analysis of Mahathir’s economic management over three almost distinct phases – 1981-85, 1986-97, and 1998-2003. Each phase can be seen as involving policy responses to a preceding crisis, but also as envisioning a new stage and type of development.

First Phase: 1981-1985

In his first five years in office, from 1981 to 1985, Mahathir utilized greater state intervention to promote heavy industrialization and domestic imitations of Japanese sogososhas. The slogan of the period was “Look East” to emulate Japan and South Korea. Yet this was a difficult period when the world economy faced a recession following oil price hikes and interest rate increases instituted in 1980 by Paul Volcker, newly appointed chairman of the U.S. Federal Reserve Bank. The Malaysian economy was badly affected by falls in primary commodity prices as demand for manufactured exports fell.

For a year after becoming prime minister, Mahathir seemed to endorse Finance Minister Tengku Razaleigh Hamzah’s counter-cyclical pump-priming efforts to turn the economy around by increasing public spending. However, after winning the April 1982 general election, Mahathir imposed an “austerity drive” that reduced government spending and placed state-owned enterprises under closer scrutiny. Notably exempted from the austerity drive was the state-sponsored and HICOM-led program of heavy industrialization. This program signaled a second round of import substitution. Often implemented in joint-ventures with Japanese firms, the HICOM enterprises were primarily financed by heavy borrowing from the Japanese government at very low interest rates.

This mixed approach of reversing public sector expansion while changing the course of state intervention was accelerated by Daim Zainuddin after he was appointed finance minister in 1984. Daim, with Mahathir’s endorsement, made significant economic policy reversals, including regressive fiscal (tax and spending) reforms, more stringent public expenditure cuts, privatization, deregulation, and financial liberalization. The 1985-86 recession was the culminating economic crisis of this first phase of Mahathir’s management of the economy, for which Mahathir and Daim were blamed in the run-up to the UMNO split of 1987.

Second Phase: 1986-1997

Just as the first phase was not uniformly marked by growing state intervention, government spending, or regulation, the second phase was not a simple headlong rush towards the economic liberalization pushed by the so-called Washington Consensus. Mahathir permitted selective economic and cultural deregulation and partial privatization.

From 1985 onwards, Mahathir and Daim’s investment regime reduced business regulation for inter-ethnic redistribution purposes formerly required by the Industrial Coordination Act 1975 and the restructuring objective of the New Economic Policy. The Promotion of Investments Act 1986 attracted export-oriented manufacturing investments and reduced the insulation between export-oriented and domestically-oriented production. The new investment regime significantly encouraged higher value-added export-oriented industries, skill development, and technology up-grading. 

Wave of Growth

In 1985, the G-7 governments, via the Plaza Accord, acted to raise the value of the Japanese yen against the U.S. dollar. Malaysia’s yen-denominated sovereign debt doubled in ringgit terms. Bank Negara responded to the mounting foreign debt burden and to the collapse of commodity prices by letting the ringgit depreciate against the U.S. dollar, effectively securing some competitiveness through devaluation. Among other reasons, the sharp appreciation of the yen, then the Taiwanese dollar and the South Korean won, encouraged the relocation of Japanese, Taiwanese, and South Korean industries to China and Southeast Asia, including Malaysia. This new wave of foreign direct investment helped to usher in a decade of structural transformation and rapid growth that only ended when the “East Asian financial crisis” erupted in July 1997.

However, Malaysia’s strong economic recovery did not quite head off the banking crisis building up from the 1980s’ recession, commodity price collapse, and bursting of property and stock market bubbles. In 1987-88, almost 30 percent of commercial bank loans were “non-performing.” The government was compelled to oversee and regulate more strictly the financial system, using the Banking and Financial Institutions Act 1989 and other regulations. More prudent and stricter banking supervision limited Malaysian exposure to (private) foreign borrowing. For example, private interests needed Bank Negara’s approval to borrow from abroad, notably by showing that borrowed funds would generate foreign exchange earnings.

The economic recovery was followed by financial liberalization, especially in stock market development. Despite the banking failures and stock market collapse of the late 1980s, Mahathir and Daim persisted with stock market promotion albeit with stricter banking regulation. But as if the problems from the 1980s banking crisis had been forgotten, commercial banks again lent generously and again induced property and stock market bubbles. Many Malaysian corporations, especially those associated with the regime’s “cronies,” were very highly leveraged. The consequences of these economic and financial developments were mixed and, as it turned out in 1997, disastrous. 

Third Phase: 1998-2003

During the third phase, Mahathir’s economic management resorted to unorthodox counter-cyclical interventions to stimulate economic recovery and sustain growth in the face of a more adverse international environment. When the 1997 crisis erupted, it was widely blamed on East Asian corruption, cronyism, and nepotism. No one should condone these well known abuses in the countries that were severely stricken, namely Thailand, Indonesia, South Korea, and Malaysia. Yet the real roots of the crisis lay in the global trends of liberalization and deregulation that abetted bias, abuse, and systemic failure in the international financial system that emerged after the Bretton Woods framework of fixed exchange rates was abandoned in 1971.

At the onset of the 1997 financial crisis, Malaysia had lower levels of foreign debt compared to Thailand, Indonesia, and Korea, because Bank Negara had limited short-term foreign borrowings. But the ensuing “loss of investor confidence” in East Asia caused easily reversible portfolio investment, so-called “hot money,” to exit quickly from the region. Hence, the Malaysian financial system was no less vulnerable because of the far greater role of foreign investments in the relatively larger Kuala Lumpur stock market.


Controversy and Rift

Mahathir’s early responses to the crisis exacerbated the situation. Meant to stem the capital outflow, his quixotic attempts caused foreign portfolio investments to stampede out of the country. Mahathir also seemed overly anxious to protect cronies whose indebtedness and heavy losses of asset value were as much due to their own excesses as any “contagion” from the regional crisis. Mahathir and Daim had Deputy Prime Minister and Finance Minister Anwar Ibrahim suspend KLSE rules to allow the leading crony UEM-Renong conglomerate to organize a bailout. That move caused the stock market capitalization to fall by RM70 billion, or 20 percent, in three days in November 1997. To this humiliation Anwar responded by sidelining Mahathir’s preferences and securing Cabinet support for a new, pro-cyclical policy package in December. Then Mahathir established a virtually unaccountable supra-cabinet creation, the National Economic Action Council (NEAC), which was reminiscent of the 1969 National Operations Council.

These policy divergences between Mahathir and Anwar had little time to deepen. Anwar himself realized the folly of following contractionary policies and began to reverse them in the second quarter of 1998. But in May, Soeharto was overthrown in Indonesia. In June, [UMNO Youth President] Ahmad Zahid openly criticized “nepotism” and “cronyism” at the UMNO Youth assembly. Suspecting Anwar of plotting a “palace coup” against him, Mahathir sacked Anwar on 2 September 1998.

Capital Controls’ Limited Impact

One day earlier, Bank Negara controversially imposed capital controls. With hindsight, I would argue that Mahathir’s capital controls and recovery package were well designed and enforced, but too late, biased, and unnecessary.

Mahathir’s crisis management was correct in one central and critical respect. He opted for a counter-cyclical thrust in opposition to the International Monetary Fund and the market’s pro-cyclical preferences. In doing so, he went against economic orthodoxy by reversing his pre-crisis commitment to capital account convertibility. Imposed 14 months into the crisis, with stock market de-capitalization exceeding 75 percent, the capital controls had questionable practical value – except to prevent further “bleeding” and perhaps to weather another crisis due to the huge ringgit overhang in Singapore.

To be fair, Mahathir’s capital controls seemed eminently sensible in September 1998 when there seemed to be no end to the crisis. Worse, a crisis developed in Russia which triggered the collapse of the U.S. hedge fund, Long Term Credit Management (LTCM). The LTCM debacle itself ended “denial” in the U.S. that the market could be at fault. The U.S. Federal Reserve bailed out LTCM and lowered interest rates which helped to stabilize East Asian currencies and eventually permitted regional recovery to begin.

Cost of Recovery

The government had established Danaharta, Danamodal, and the Corporate Debt Restructuring Committee to restore banking liquidity, manage non-performing loans, re-capitalize banks, and restructure the banking system and major conglomerates. Now it has become clear that the efforts of these three agencies were variously biased and abused, in practice if not in intent.

When it took over billions of ringgit of corporate debt, the government hardly penalized the borrowers. Ostensibly this was because some of them were said to have been performing “national service” with their borrowings. Moreover, the government used public funds to “re-nationalize” privatized assets at prices far exceeding market levels. Critics charged that the regime’s cronies were doubly blessed – first by benefiting from privatization, and then by walking away unscathed from their debts and liabilities. Despite such abuses, Danaharta, Danamodal, and the Corporate Debt Restructuring Committee managed to restore essential liquidity. Meanwhile, rising government spending and increased global demand for electronics facilitated a strong economic recovery in 1999-2000.

Much to Answer For

 Since then, Malaysia’s growth has slowed owing to the economy’s continued vulnerability to global conditions. The Clinton era boom has ended. Japan and much of Europe are economically lethargic. And with keener competition from lower cost producers having competitive skill endowments, notably China, Malaysia’s prospects for continued export-oriented growth are insecure. Presently, it is scarcely comforting that the government’s post-crisis policy declarations of domestic-led growth rely largely on large budget deficits and public spending, particularly on construction projects that are popularly perceived to be more “jobs for the boys.”

Obviously, Mahathir has a lot to answer for the economic management of his “era.” He has always had a penchant for expensive prestigious projects. There was Dayabumi at the beginning of his tenure. Now, there are the new administrative capital of Putrajaya (with the prime minister’s palatial official residence at its center), the Kuala Lumpur International Airport, the Formula 1 Grand Prix race track at Sepang, and the Petronas-owned Kuala Lumpur City Centre Twin Towers.

Despite his attacks on currency speculators, Mahathir’s government was responsible for very expensive speculative failures. Bank Negara suffered a multi-billion ringgit loss from its massive purchases of sterling before the sterling’s collapse in September 1992. In the 1980s, the government lost several hundred million ringgit in a disastrous attempt to corner the international tin market.

No Accounting

Besides, the government’s absorption of corporate losses reached new heights under Mahathir. Perwaja, the steel-making corporation, is a spectacular failure, having lost more than RM10 billion by the mid-1990s. Bank Bumiputra Malaysia was scarcely better. Before it was acquired by Bank of Commerce, Bank Bumiputra had been re-capitalized several times with several billion ringgit of public funds.

As yet, there is no careful accounting of the losses associated with privatization followed by re-nationalization. Public assets were privatized at a discount, but re-nationalized at premiums that were enjoyed by their non-performing beneficiaries. In short, we have experienced 20 years of privatizing profits and profitable assets, and socializing losses and liabilities.

Arguably, the cumulative impact of Mahathir’s economic management was not an unmitigated disaster partly because his policies and underlying concerns were not motivated by Mahathir’s own predatory intentions. Many critics, however, argue that notable instances of self-aggrandizement in major policies were more characteristic of Mahathir’s associates led by Daim, his economic czar. Still, Mahathir should bear responsibility for his own flawed policies, for major failures in implementation, and for not checking abuses in high places, political and corporate. If anything, too many so-called corporate captains have demonstrated an addiction to direct and indirect subsidies, discounts, incentives, and bailouts. But these huge costs to the national economy have not been repaid by enhanced tax revenue arising out of efficient and productive privatization.

The new regime Abdullah Badawi leads after October 2003 may have reason to rue Mahathir’s inconsistencies and checkered record together with the political crises into which Mahathir threw UMNO and the political system. Abdullah needs to consolidate his party base. He can only do so with limited and conditional access to UMNO’s finances after those were re-organized beyond proper accountability to UMNO’s leadership after the party split in 1987-88.

Abdullah will also try to retrieve UMNO’s battered support among Malay voters, many of whom blame Mahathir’s policies and mismanagement for the post-1985 and post-1997 economic and political crises. Hence, it is probable Abdullah’s team will simultaneously turn to NEP-type ethnic preference policies and resort to neo-liberal economic policies. They can be expected to juggle between relying on the state – an option preferred by those who want to re-emphasize interethnic wealth redistribution – and depending on the market – the preferred option of big business and most academic economists.

No matter how Abdullah responds to the challenges he inherits, he will be searching for options under a long shadow cast by 22 years of Mahathirist economics.

Jomo K.S.
Jomo K.S. is a professor in the Faculty of Economics and Administration, University of Malaya.

Kyoto Review of Southeast Asia. Issue 4 (October 2003). Regional Economic Integration