By Chong Pooi Koon | Oct 20, 2011
Bloomberg

Lim Guan Eng turned Malaysia’s second-smallest state into the nation’s biggest economic success after he bumped into two National Instruments Corp. (NATI) executives at the local airport in 2008.

Elected in March that year as Penang’s first chief minister from an opposition party in 36 years, Lim was struggling with the prospect of federal funding cuts. He convinced the managers to set up a research and production center in the state, and within two years the former British trading post was Malaysia’s top destination for foreign manufacturing investment.

“The deal was struck very quickly,” said Eugene Cheong, a director at the local unit of the Austin, Texas-based maker of industrial testing and automation equipment.

Lim’s speed in closing deals with companies from National Instruments to Robert Bosch GmbH is helping Penang achieve what every Malaysian prime minister sought since Mahathir Mohamad started his Multimedia Super Corridor technology zone in the 1990s near Kuala Lumpur: a transition from low-cost assembly to a research and development base for industries such as solar cells and life sciences.

With a general election due by early 2013, Penang’s progress highlights the challenges facing the rest of Malaysia and the National Front government as China, Indonesia and Vietnam offer investors bigger workforces while Singapore lures talent with lower taxes and easier immigration. Lim, 50, the country’s only ethnic-Chinese state leader, embodies the contrast between Penang’s business transparency and the four- decade old policies of the ruling party that favor Malays, which the World Bank says undermine competitiveness.

‘Been Sleeping’

“We’ve been sleeping,” said Ooi Kee Beng, Penang-born author of “Era of Transition: Malaysia after Mahathir” and a senior fellow at the Institute of Southeast Asian Studies in Singapore. “Penang now has a chance to show that if you have good governance, and if you put fairness and justice as your main qualities, free of race considerations, that is actually the way to go for Malaysia.”

In the first seven months of 2011, Penang won 3.6 billion ringgit ($1.2 billion) of approved foreign manufacturing investment, ahead of the 3.4 billion ringgit that went to Selangor, the state that surrounds the capital Kuala Lumpur, a government report showed last month.

It’s not the first time the state has set the pace for technology investment in Malaysia. Penang, a base for the spread of British influence in the 18th century, was the center of a manufacturing push in Malaysia’s shift from rubber and tin production in the 1970s, attracting companies including Intel Corp. (INTC) and Robert Bosch to assemble chips and build car radios.

Political Alternative

Penang’s economic resurgence may bolster the opposition alliance’s claim it can be an alternative to the National Front, which has run the country since independence from British rule in 1957. A national election may be called with 60 days’ notice at the discretion of Prime Minister Najib Razak.

“A lot of this has to do with the dynamism of the chief minister,” said Ong Kian Ming, a political analyst at UCSI University in Kuala Lumpur and columnist for the Edge newspaper.

Lim has managed to keep Penang attractive for international companies even as Najib focuses federal support on regions such as Johor and Sarawak, where his ruling coalition has among its biggest parliamentary-seat majorities.

Under Najib’s Economic Transformation Program, his government is promoting about 65.8 billion ringgit of private- sector-led projects for southern Johor state, compared with at least 375 million ringgit for Penang, according to data compiled by Bloomberg. The comparison excludes projects covering multiple states or those without a clear single location, which amounted to 34.3 billion ringgit nationwide.

Federal Support

“Investment decisions are made on the basis of need not politics,” said Tengku Sariffuddin Tengku Ahmad, a spokesman for the prime minister. “Over the last year we have invested more than 1 billion ringgit of federal funding in Penang and will continue to support their economic progress in whatever way we can,” he said in an e-mail.

Malaysia’s efforts to woo investments in recent years may have been hampered by its policy of giving preferential treatment to ethnic Malays and some indigenous groups, collectively known as Bumiputera, in government jobs, contracts, education and cheaper housing, said Ooi.

When the economy was booming along with its neighbors before the 1997-98 Asian financial crisis, the effects of the policy were less apparent, he said. When growth slowed, the race-based program became a greater damper, according to Ooi. While the nation outperformed rivals in the early and mid 1990s, it has struggled to maintain that edge since the regional crisis.

Malay Contracts

Under federal rules, government construction contracts valued below 200,000 ringgit must be given to indigenous or Malay contractors. In addition, a main goal of the affirmative action programs was to raise the Bumiputera share of corporate stock ownership to at least 30 percent.

Najib said Sept. 27 that the programs, introduced in the early 1970s to reduce poverty and narrow income disparities between different ethnic groups, are becoming more merit-based.

In an interview in his 28th floor office, where the walls are lined with paintings and sketches of Penang, some from the 19th century, Lim said the relationship between state and central government wouldn’t hold Penang back.

“We may have political differences but we are cordial and professional,” he said as he sipped ginseng tea made by his wife. “If Penang fails, Malaysia fails.”

Ambiguous Practices

To prevent corruption, Penang requires open bidding on contracts of more than 200,000 ringgit and has awarded about 125 million ringgit of jobs through competitive tenders, according to Lim. Transparency International said in a 2009 report that Penang, an island and coastal enclave linked by a 13.5-kilometer (8.4-mile) bridge, was Malaysia’s first state to implement open tenders for government contracts.

While Lim said his government awards contracts based on merit within the national guidelines, the federal government states that it has no obligation to accept the lowest offer or to give any reason for rejecting a bid. Under Malaysian federal rules, agencies are only required to invite quotations from at least five bidders for works contracts.

“In domestic tenders, preferences are provided for Bumiputera suppliers and other domestic suppliers,” the U.S. Department of State said in a March report on Malaysia’s investment climate. Implementations of the affirmative action policy “vary greatly; some practices are explicit and contained in law or regulation while others are informal, leaving much ambiguity for potential investors,” it said.

Trained Accountant

The Malaysian government says it is also pushing for greater transparency, including introducing a whistleblower protection act to fight corruption and a planned competition law next year.

“Open tender is a virtue, it’s a policy that is being pushed through federally too,” Idris Jala, a minister in the Prime Minister’s Department and chief executive officer of the government’s Performance Management and Delivery Unit, said in Singapore yesterday. “For a country to grow, to become high income, we must have competitiveness.”

Lim, who holds a Bachelor of Economics from Australia’s Monash University, says his training as an accountant helps him spot any discrepancies in state finances.

Property developers such as Ivory Properties Group Bhd. (IVORY) will benefit from the inflow of workers and expatriates to support Penang’s industries, while local electronics companies Eng Teknologi Holdings Bhd. and Globetronics Technology Bhd. (GTB) may gain from orders to supply foreign manufacturers, said Choo Swee Kee, who manages about 700 million ringgit as chief investment officer of TA Investment Management Bhd. in Kuala Lumpur.

Property Shares

Eastern & Oriental Bhd. (EAST), which is reclaiming up to 980 acres of land to build luxury homes in what it says is the island’s largest seafront development, has seen its shares soar 25 percent this year. The main FTSE Bursa Malaysia KLCI Index slid 4.5 percent during the same period.

“We have been a believer of Penang’s potential for a long time,” said Eric Chan, deputy managing director of E&O, which also owns the 126-year-old Eastern & Oriental Hotel in the island’s historic Georgetown. “China is no longer cheap and some global companies are looking to move their operations to alternative locations like Penang.”

Lim says ethnic Malays also benefit from the state’s economic growth. In the Malaysian state with the highest proportion of ethnic Chinese, at 42 percent, Malay contractors have won most of the jobs awarded by his government through the open tenders, Lim said. The Malay community doesn’t need racial quotas to succeed, he said.

Brain Drain

“We have proven that this is the way forward,” Lim said in an interview in July on Penang Hill, at an event promoting the state’s efforts to woo talent. “Malaysia has a historical opportunity for change.”

Malaysia’s racial policies spurred a brain drain of largely Chinese and Indian minorities, and limited foreign investment, Philip Schellekens, a senior economist at the World Bank, said in April. In its latest Malaysia Economic Monitor report that month, the Washington-based lender said the migration of talent out of Malaysia undermines the country’s aspiration to become a high-income nation.

“Discontent with Malaysia’s inclusiveness policies is a key factor,” the World Bank said. “Productivity and inclusiveness lie at the heart of Malaysia’s transformation programs. Implementing these forcefully will go a long way towards turning the brain drain into a gain.”

Growth Impediment

The U.S. Department of State said that Malaysia’s “complex network of preferences” to promote the acquisition of economic assets by ethnic Malays and other indigenous groups is a “significant impediment” to economic growth. The country’s affirmative-action policy is unique among Southeast Asian neighbors including Thailand, Singapore, Indonesia and the Philippines.

“It clearly slows things as many competent people leave Malaysia because of it,” said Jim Rogers, the chairman of Rogers Holdings who moved to neighboring Singapore from New York in 2007. Malaysia should “abolish the policy and open the economy and society to all” to boost its competitiveness among international investors, he said in an e-mail. Proposed changes to the policy are making the country more attractive, he said.

Malaysia’s economy expanded at an average pace of 9.2 percent from 1990 through 1997, compared with the 7.1 percent for newly industrialized Asian nations as a group, International Monetary Fund data show. By contrast, Malaysia’s 5.1 percent average growth since 1999 is little more than the group’s 4.8 percent overall mean performance, according to the IMF.

Beating Singapore

Mahathir’s Multimedia Super Corridor, centered around an area in Selangor state that was carved out of oil palm plantations, offered tax breaks and relaxed rules on hiring foreigners to entice software engineers.

While Penang lured research, development and production, the MSC’s more notable successes were getting information- technology support and service centers for companies including Royal Dutch Shell Plc (RDSA) and Deutsche Post AG’s DHL division. The government later broadened the incentives to include companies that weren’t physically located in the main MSC area.

To win the investment in Penang from National Instruments, Lim had to overcome rivals from Singapore and the Philippines to Vietnam and China.

Tax Breaks

Stuttgart, Germany-based Robert Bosch will spend 520 million euros ($720 million) on a factory in Penang that will be one of its largest, employing 2,000 workers to make photovoltaic solar modules. Agilent Technologies Inc. told local media in March it was adding a life-sciences facility that undertakes research and development. Both companies have operated in Penang for about four decades, starting in the 1970s, when foreign investors used the state’s cheap labor to make low-end electronics parts.

The state can’t offer tax breaks for investors or sell bonds, both controlled by the federal government, so it plans to use revenue from local land levies to build more roads and a third bridge linking the island to its mainland territories, according to Lim, who is also secretary-general of the opposition Democratic Action Party.

Penang, bigger only than Perlis of Malaysia’s 13 states, is used to an underdog status. Founded by Captain Francis Light in 1786 after the East India Co. took over the island from the Kedah Sultanate, Britain set it up as a trading post to break Dutch Malacca’s monopoly of the spice trade.

Paddy Fields

Intel spent $1.6 million in 1972 to set up the company’s first offshore chip assembly plant in the state amid paddy fields, employing 100 batik-clad workers. Now, it also designs semiconductor devices in the state.

Penang had 16 percent of the country’s approved foreign manufacturing investment from 2006 to March this year, government data show. The state, a tourist destination with beach resorts and a colonial-era town designated as a United Nations World Heritage site, made up 8.1 percent of Malaysia’s gross domestic product in 2009, based on constant prices.

“The change in government meant that you have reenergized this place,” said Chris Ong, who owns boutique hotels converted from heritage buildings in Penang. “The old state government was here for far too long.”