Are Government-Linked Corporations Crowding out Private Investment in Malaysia?

Menon , Jayant; Ng, Thiam Hee Working Paper Are Government-Linked Corporations Crowding out Private Investment in Malaysia? ADB Economics Working Paper Series, No. 345 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Menon , Jayant; Ng, Thiam Hee (2013) : Are Government-Linked Corporations Crowding out Private Investment in Malaysia?, ADB Economics Working Paper Series, No. 345, Asian Development Bank (ADB), Manila, https://hdl.handle.net/11540/2317 This Version is available at: https://hdl.handle.net/10419/109468 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Jayant Menon and Thiam Hee Ng No. 345 | April 2013 ADB Economics Working Paper Series Are Government-Linked Corporations Crowding out Private Investment in Malaysia? Private investment in Malaysia never fully recovered from the Asian financial crisis. One explanation relates to the crowding-out effect of the growing dominance of government-linked corporations (GLCs) in many sectors. For the first time, we present evidence confirming this effectwhen GLCs dominate an industry, investment by private firms is significantly negatively impacted, and vice-versa. About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two-thirds of the world’s poor: 1.7 billion people who live on less than $2 a day, with 828 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org/economics Printed on recycled paper Printed in the Philippines ADB Economics Working Paper Series Are Government-Linked Corporations Crowding out Private Investment in Malaysia? Jayant Menon and Thiam Hee Ng No. 345 April 2013 Jayant Menon is Lead Economist and Thiam Hee Ng is Senior Economist from Office of Regional Economic Integration, Asian Development Bank. We are grateful to participants at the MIER Annual Outlook Conference in Kuala Lumpur from 4–5 December 2012 for useful comments and discussions. Anna Cassandra Melendez provided excellent research assistance. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org © 2013 by Asian Development Bank April 2013 ISSN 1655-5252 Publication Stock No. WPS135660 The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. By making any designation of or reference to a particular territory or geographic area, or by using the term “country” in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area. Note: In this publication, “$” refers to US dollars. The ADB Economics Working Paper Series is a forum for stimulating discussion and eliciting feedback on ongoing and recently completed research and policy studies undertaken by the Asian Development Bank (ADB) staff, consultants, or resource persons. The series deals with key economic and development problems, particularly those facing the Asia and Pacific region; as well as conceptual, analytical, or methodological issues relating to project/program economic analysis, and statistical data and measurement. The series aims to enhance the knowledge on Asia’s development and policy challenges; strengthen analytical rigor and quality of ADB’s country partnership strategies, and its subregional and country operations; and improve the quality and availability of statistical data and development indicators for monitoring development effectiveness. The ADB Economics Working Paper Series is a quick-disseminating, informal publication whose titles could subsequently be revised for publication as articles in professional journals or chapters in books. The series is maintained by the Economics and Research Department. Printed on recycled paper CONTENTS ABSTRACT v I. INTRODUCTION 1 II. OVERVIEW OF GLC PRESENCE AND THE GLC TRANSFORMATION PROGRAM 2 III. HOW COULD GLCS CROWD OUT PRIVATE INVESTMENT? THEORY AND EVIDENCE 8 IV. DATA 9 V. MODEL AND METHOD 12 VI. RESULTS 13 VII. CONCLUSION 14 REFERENCES 15 ABSTRACT    Private investment in Malaysia has been sluggish since the Asian financial crisis. One explanation is that the growing presence of government-linked corporations (GLCs) has been crowding out private investment. For the first time, we provide empirical evidence on the relationship between GLC presence and private investment. We find that when GLCs are dominant in an industry, investment by private firms is significantly negatively impacted. Conversely, when GLCs do not dominate an industry, the impact on private investment is not seen. To revive private investment in Malaysia, government must not only redress its growing fiscal deficit, but also expedite its program of divestment. Keywords: Malaysia, private investment, government-linked corporations, crowding-out effect JEL Classification: E22, F20, F21, J78, O53 I. INTRODUCTION Private investment in Malaysia has never fully recovered from the impact of the Asian financial crisis (AFC). Both domestic and foreign investment has remained lackluster post-AFC. While foreigners continue to shun Malaysia, it seems even domestic investors are fleeing as well, with Malaysia becoming a net exporter of capital since 2005. High and persistent fiscal deficits suggest that public investment will not be able to fill in the gaps left by the slump in private investment. Malaysia continues to grow but, without private investment, it is unlikely to break out of the middle-income trap. The Malaysian government recognizes the need to revive private investment if it is to realize its vision of achieving developed country status by 2020. The Tenth Malaysia Plan (TMP) projects a sharp increase in private investment, requiring it to grow by more than 12% annually over the next 5 years, a significant increase from the 2% annual growth achieved in the Ninth Malaysia Plan. Private investment’s contribution to gross domestic product is targeted to reach almost 20% by 2020, again a very sharp rise compared to recent history. The government also appears to recognize that government-linked corporations (GLCs) could be crowding out private sector investment and standing in the way of realizing private investment targets. The Economic Transformation Program (ETP) has called for a reduced role of government in business, and a program of divestment is already in place. But the problem is on-going. It appears that GLCs are still investing in new sectors during the divestment program. There has been a spate of acquisitions of late by GLCs in private sector finance and property developers (see Jacobs 2011), making it more of a diversification than a divestment program. The influence of GLCs, however measured, continues to be both widespread and pervasive. Menon (2012) finds that the GLC share is approximately one-third in the aggregate (irrespective of the measure of firm presence employed) and that they control more than half the industry share of operating revenue or income in utilities, transportation and warehousing, agriculture, banking, information communications, and retail trade. Although it is often recognized that GLCs are crowding out investment in Malaysia, there has been no empirical evidence to support this assertion. This paper overcomes this gap by testing this empirical relationship. The remainder of the paper is in six parts. To set the stage, Section II measures the role and influence of GLCs in the Malaysian economy, and describes the government-sanctioned GLC Transformation Program. The theory and evidence on the relationship between GLCs and private investment is discussed in Section III. Section IV describes the database that we use, while Section V presents the model and methodology. The results are discussed in Section VI, while a final section concludes. 8 І ADB Economics Working Paper Series No. 345 IHH Healthcare Bhd (IHH), and palm oil producer Felda Global Ventures Holdings Bhd (Felda). These two IPOs alone raised some $6.0 billion from the market, and reduced government’s stake in IHH from 62% to less than half, and in Felda to 40% (Grant 2012).5 More than its divestment record, however, the success of the GLC Transformation Program is increasingly being judged in terms of performance of the GLCs. The preferential treatment accorded GLCs, and the impact that they may have in crowding out private investment, suggests that their superior performance is potentially artificially generated, and comes at a high cost. Nevertheless, if it continues to be based on performance, whether real or artificial, the divestment function of the GLC Transformation Program is likely to be sidelined. A further disincentive for private firms is likely to arise from GLCs’ continued links to government affirmative action policies. The New Economic Policy (NEP) targets of this program was based on stock rather than flow measures, namely a redistribution of wealth rather than income, with a view to reaching a Bumiputera wealth ownership share of 30%. Many GLCs were created in order to pursue this objective. Section II of the GLC Transformation Manual (pp. 20–21) explicitly states that: …the GLC Transformation Program will continue to be a significant policy instrument to execute Government’s policies with regard to the development of the Bumiputera community, with the ultimate aim of preparing the Bumiputera community and the nation towards greater competitiveness. PCG believes that the objectives of making GLCs better performing companies and the development of genuine Bumiputera suppliers and vendors as well as the development of Bumiputera human capital within GLCs are not mutually exclusive but, rather, mutually reinforcing objectives. The aim is to strive towards a mutually reinforcing relationship where stronger GLCs are able to be better developers of Bumiputera small and medium-sized enterprises and human capital that in turn contribute to the strengthening of the GLCs themselves. All of this may sound good in theory but, how does it work out in practice? The data shows that income inequality within the Bumiputera community has worsened considerably, and that of all groups, unemployment is highest amongst Bumiputera graduates (see Lee and Nagaraj 2012, Menon 2012, Zin 2012). It does raise the question as to whether the right instrument is being used to pursue a policy objective. That is, are the GLCs the right instrument for pursuing affirmative action policies? The answer is almost certainly “no,” given that GLC performance is artificially generated, subject to manipulation and capture, and therefore unlikely to be sustainable in the long run (Gomez 2012). The multiple objectives assigned to GLCs may also account for the slow pace of divestment thus far. III. HOW COULD GLCS CROWD OUT PRIVATE INVESTMENT? THEORY AND EVIDENCE GLCs in Malaysia are seen to have preferential access to government contracts and benefit from favorable government regulations. An oft-cited concern relates to the preferential treatment that they receive with respect to government procurement. Hence, GLCs find it easier and more profitable to increase investment in sectors where they already have a significant presence―a 5 It should be noted however that even after the divestment, the government still retains management control. Also, GLICs seem to have taken a large portion of the shares from the divestment, suggesting that the exercise was more of a cash raising one than privatization per se (Saad 2012). Are Government-Linked Corporations Crowding out Private Investment in Malaysia? І 9 level of involvement made possible by their special and preferred status, to begin with. In contrast, private firms may be reluctant to invest in sectors where GLCs are dominant because they perceive the playing field to be skewed against them. This suggests a negative relationship between the share of GLCs in a sector and the rate of investment by private firms. The relationship may also be nonlinear in the sense that there could be a threshold effect. That is, it is only when the share of GLCs in a sector surpasses a certain limit that it could have a deterrent effect on investment by other firms. Therefore, we would expect that the non-GLCs would tend to invest less in industries where GLC firms are dominant. There have only been a few empirical studies on how the presence of governmentowned corporations affects investment by other firms. For Malaysia, Razak et al. (2011) set out to examine a related issue by looking at the relative performance of 210 listed firms between 1995 and 2005 to see if ownership matters. They report mixed results, with the relative performance of GLCs and non-GLCs as a group critically dependent on the inclusion of a few, large GLCs. The small sample size and sensitivity of the results to inclusion of a handful of firms prevent any robust conclusions to be drawn, unfortunately. Dewenter and Malatesta (2001), on the other hand, examine the differences in efficiency between the characteristics of a sample of very large global private and state-owned firms. They find that government firms are much less profitable than private firms. In addition, government-owned firms also tend to have greater leverage and a higher level of labor intensity. Other studies have focused on the effect of investment through the availability of credit where government-owned firms are seen to have preferential and easy access to credit. Harrison and McMillan (2001) examine the response of private and state-owned firms to greater foreign direct investment in Ivory Coast. There are concerns that borrowing by foreign firms could crowd out domestic firms’ access to the limited bank funding available. They find that state-owned firms are less credit constrained than domestic firms and that only private firms are crowded out by higher borrowings by foreign firms. Ramirez and Tan (2004) set out to examine the behavior of GLCs in Singapore, focusing on the differences in the characteristics between GLCs and non-GLCs. They find that GLCs in Singapore do not enjoy preferential access to finance. This is not that surprising given the financial market in Singapore is well developed and their sample consists of listed firms only. There should be plenty of information available on listed firms and the listing process in Singapore is quite stringent, suggesting that private firms are not expected to have problems in getting finance. Despite the relatively small size of their sample, they find that the stock market values GLCs at a premium, suggesting that there is some evidence that the market perceive some intangible benefits by purely being a GLC. IV. DATA In our empirical analysis, we will be focusing on non-financial firms as we are interested in the investment behavior of non-financial companies. The investment behavior of banks will be quite different. Taking out the financial firms, we end up with a sample of 28 non-financial GLCs from the Putrajaya Committee list. These GLCs are found in 16 industries. For our empirical analysis, we compare the investment behavior of the GLCs with that of other private firms. To do that, we also collect information on all listed private firms that are operating in the same 16 industries as the GLC. Both GLC and private firms’ corporate data are obtained from the Oriana database. Our empirical analysis covers the period from 2007 to 2011. Hence, the panel dataset we are using for analysis consists of annual corporate data from 2007 to 2011 for a total of 443 firms. 10 І ADB Economics Working Paper Series No. 345 Tables 4 and 5 present summary statistics of the non-GLCs and GLCs in our sample. The data shows that GLCs tend to be much larger than non-GLCs. In terms of fixed assets (toas_m), GLCs are on average about nine times larger than non-GLCs. The median GLC is almost seven times larger than the median non-GLC. Table 4: Summary Statistics for Non-GLC Firms V ariable Mean Median Std. Dev Min Max Investment/Fixed Assets 0.22 0.10 0.98 –0.89 30.42 Sales/Fixed Assets 2.20 1.01 6.26 0.00 188.45 Q-Ratio 1.17 0.76 2.02 –6.88 30.63 Total Assets (RM million) 397.00 100.00 1262.00 38.00 17,106.00 Return on Assets (%) 3.61 4.10 11.15 –81.84 72.69 Return on Equity (%) 3.28 7.60 44.17 –860.95 265.79 Source: Authors’ computatations using Oriana database. Table 5: Summary Statistics for GLC firms V ariable Mean Median Std. Dev Min Max Investment/Fixed Assets 0.29 0.18 0.92 –0.93 8.76 Sales/Fixed Assets 1.96 1.12 2.25 0.17 10.39 Q-Ratio 1.81 1.71 0.99 0.34 6.91 Total Assets (RM million) 3,400.00 5,414.00 27.00 876.00 25,035.00 Return on Assets (%) 9.04 7.19 9.60 –20.10 51.65 Return on Equity (%) 14.15 14.36 30.13 –241.04 71.45 Source: Authors’ computations using Oriana database. GLCs also tend to invest a higher proportion of their earnings than non-GLCs, where investment is measured as a share of fixed assets (invest_fa). GLCs are also more profitable as measured by return on assets (rtas) and return on equity (rshf). While there are substantial differences among these various indicators, the standard deviations of the indicators are also quite large. Hence, the differences between the two means for these measures are not statistically significant. Non-GLCs have slightly higher sales as a share of fixed assets (sales_fa). The median of the values is also smaller than the mean implying that there are some large values in our sample. This applies to both GLCs and non-GLCs. We also show the value of qratio which is our proxy for Tobin’s Q (the market value of the firm relative to its replacement cost). We estimate our Q-ratio using the average market capitalization of the firm during the year divided by the book value of total assets. The Q-ratios for GLCs are found to be much higher than non-GLCs. This is true for both means and medians. This suggests that the stock market places a premium on the valuation of GLCs. Are Government-Linked Corporations Crowding out Private Investment in Malaysia? І 11 Our initial look at the data shows that investment in both GLCs and non-GLCs have moved closely together but median investment as share of fixed assets by non-GLCs have consistently been lower than that of GLCs (Figure 1). Meanwhile, the median size of GLCs as measured by total assets has been rising at a much faster rate than that of non-GLCs (Figure 2). Figure 1: Investment as a Share of Fixed Assets (median) Source: Authors’ computatations using Oriana database. Figure 2: Total Assets (median) Source: Authors’ computatations using Oriana database. 0 5 10 15 20 25 2008 2009 2010 2011 % Non-GLC GLC 0 500 1,000 1,500 2,000 2,500 RM million 2008 2009 2010 2011 Non-GLC GLC 12 І ADB Economics Working Paper Series No. 345 V. MODEL AND METHOD In order to model the investment behavior of the GLCs and private firms, we estimate a modified version of the standard neoclassical investment model. Theory suggests that investment should depend on the expected profitability from investing an additional dollar of capital (Hubbard 1998). This expectation can be captured by the marginal value of Tobin’s Q. As marginal values are not available, we use the average value of the Tobin’s Q instead. Expectations of higher profitability should lead to a higher investment rate, hence we can expect the coefficient for Q- ratio to be positive. Previous empirical results also suggest that investment spending is correlated with lagged output values via the accelerator effect. As a proxy, we use previous year sales levels to proxy for the lagged output effect. Strong growth in the previous year suggests that firms are likely to invest more in the current year. Hence the coefficient for lagged sales is expected to be positive as well. Profitability and the accelerator effect should be able to account for most of investment behavior at the firm level. However, if firms’ investment behaviors are affected by the presence of GLCs, the share of GLCs in the sector could also affect investment. To capture this effect, we augment our investment equation with the share of revenue by GLCs in the particular sector. Non-GLCs operating in industry with large GLC presence are expected to have lower rates of investment. Hence, the equation for our estimated investment equation can be written as:  1 11 2 3 11 it it it jt it it it I Sales qGLC KK               (1) where, 1it it K Iis the investment as a share of fixed assets of firm, i and time t , 1it q is the Tobin’s Q ratio, 1 1 it it Sales K   = operating revenue of the firm normalized as a share of fixed assets, and jt GLC is the share of GLC firms’ revenues in each industry j which proxies for the dominance of GLC firms in the industry. In our estimation of equation (1), we have the choice of using a random effects or a fixed effects model to control for unobserved variables in the model. It is possible that there are factors that could affect investment that are not taken into account in the regression—examples include “animal spirits” or business sentiment, or firm-specific factors such as managerial talent. For a random effects model to be valid, the unobserved variables should be distributed independently of the observed variables. This is unlikely to be the case. We can imagine that firms with higher revenues could attract more aggressive risk-taking managers, for instance. Therefore, we favor the use of a fixed effects model. In a fixed effects model, the individual firm effect is a random variable that is allowed to be correlated with the explanatory variables. We are also assuming that the unobserved variable is unchanged over time. This assumption looks plausible in our model as the time period under consideration is quite short at 4 years. The use of a fixed effects model also allows us to control for firm-level heterogeneity that is likely to be present in our large sample of firms. Are Government-Linked Corporations Crowding out Private Investment in Malaysia? І 13 VI. RESULTS The results from our fixed effects regression are presented in Table 6. We find that operating revenue and the share of GLC sales in an industry are both significant, with the expected signs. That is, the coefficient for sales is positive as higher sales in the previous period lead to higher investment in the current period. On the other hand, the coefficient for GLC share of revenues in an industry is negative, suggesting that strong GLC presence in an industry reduces the amount of investment undertaken by other firms in the same industry. We find that the Tobin’s Q is not significant. It is generally the case that the effects of this variable are difficult to capture in empirical estimations, due particularly to difficulties with measurement. Given our data, we are only able to provide a relatively poor proxy for the Q ratio, which may account for the insignificant result for this variable. Table 6: Panel Regressions Estimates Dependent Variable: Investment/Fixed Assets Explanatory Variables Fixed Effects Fixed Effects GLC Dominant Fixed Effects GLC Non-dominant Lagged Q-ratio –0.003 (0.208) 0.011 (0.032) 0.004 (0.02) Lagged Sales 0.0692** (0.031) 0.064** (0.032) 0.147 (0.115) GLC Share –0.011** (0.005) –0.015* (0.008) –0.013 (0.009) N 1,553 1,162 391 ** denotes significance at 5% level,* denotes significant at 10% level Source: Authors’ estimates. Our next step is to test whether there is some threshold effect when it comes to the share of GLC presence or influence in an industry. It is possible that firms tend to invest less when the share of GLC revenue in a particular industry is large. The fact that the revenue share attributable to GLCs is high may itself reflect privileges not available to other firms, and send a negative signal to potential private investors. To test for this, we split our sample into two. In one group, we include firms in industries where the share of GLC revenue is below 60%, and in the other group we include only industries where the share of GLC revenue exceeds 60%. We expect that in industries where GLC dominance is not that strong, it may not have a strong discouraging impact on investment. Our results show that in industries where GLC firms are dominant, the coefficient is significant and negative. However in industries where GLC firms are not dominant, the coefficient is not significant. This suggests that there is a threshold effect in place, whereby private investment is discouraged only when the presence or influence of GLCs in a particular industry exceed a critical level—in this case 60%. To test the robustness of this result to changes in the threshold, we vary it by 10 percentage points in both directions. We find tha this change did not affect our original finding of a negative and significant relationship between GLC share and private investment. 14 І ADB Economics Working Paper Series No. 345 VII. CONCLUSION Investment in Malaysia, both domestic and foreign, has remained lackluster since the AFC. One explanation put forward in accounting for the sluggish performance of domestic private investment relates to the crowding out effect as a result of the growing dominance of GLCs in many sectors. The continued pervasiveness of GLCs and their ability to exercise not only significant market power but to use their special access to government and regulatory agencies to their favor, suggests that they may present a formidable barrier to both competition and the entry of new private firms. In this paper, and for the first time, we provide empirical evidence on the relationship between GLC presence and domestic private investment. After accounting for the other determinants of investment, we find that GLC presence in general has a discernible negative impact on non-GLC investment in Malaysia. We also test whether there is a threshold effect when it comes to the share of GLC presence in an industry. It is possible that firms tend to invest less when the share of GLC revenue in a particular industry is large. We find that when GLCs account for a dominant share of revenues in an industry, investment by private firms in that industry is significantly negatively impacted. Conversely, when GLCs do not dominate an industry, the impact on private investment is not significant. Sensitivity tests associated with varying the threshold level confirm the robustness of this result. To revive private investment in Malaysia, government must not only redress its growing fiscal deficit, but also expedite its program of divestment. 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Private investment in Malaysia never fully recovered from the Asian financial crisis. One explanation relates to the crowding-out effect of the growing dominance of government-linked corporations (GLCs) in many sectors. For the first time, we present evidence confirming this effectwhen GLCs dominate an industry, investment by private firms is significantly negatively impacted, and vice-versa. About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two-thirds of the world’s poor: 1.7 billion people who live on less than $2 a day, with 828 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org/economics Printed on recycled paper Printed in the Philippines