The case for making Malaysia one connected production economy

As neighboring countries evolve into interconnected economic regions, Malaysia must consider its own capacity to govern such an economy. While debates on Malaysian federalism have often focused on constitutional authority, resource allocation, and responsibility distribution, these are not the only factors to consider. Integration is distinct from redistribution; a state may receive more federal transfers yet remain isolated from the rest of the country.

Another state may attract significant investment without fostering strong connections with Malaysian suppliers. A third state might boast a high GDP, yet the income generated by its productive assets does not proportionally benefit households. To move forward, Malaysia must not only address equitable resource distribution but also foster collaborative production within the Federation.

Three interconnected concepts underpin Malaysia's economic federalism: fiscal federalism, regional planning, and production federalism. Fiscal federalism deals with revenues, expenditure responsibilities, and transfers between governments. Regional planning encompasses infrastructure, transport, housing, environmental management, and public services whose economic impacts often transcend administrative boundaries.

Production federalism focuses on the relationships between industries, workers, suppliers, universities, technologies, logistics, and investment across states. Malaysia has implemented elements of all three, but these components are not sufficiently integrated. Federal budgets may finance infrastructure projects without measuring the additional production generated across neighboring states.

Investment incentives may attract factories without ensuring Malaysian suppliers are part of their value chains. State development strategies may compete for similar industries, overlooking the potential for greater collective value through regional specialization.

To create an integrated production economy, all three pillars must reinforce one another. Fiscal federalism funds capability, regional planning connects geography, and production federalism connects economic activity. While transfers are crucial, especially for states facing higher costs in delivering basic infrastructure, they alone cannot eliminate structural economic disparities.

Weak industrial linkages, limited investment, inadequate skills, and poor connectivity can benefit from additional public expenditure, but this does not necessarily transform the productive structure. Thus, Malaysia needs both fiscal redistribution and production policy.

Reforms are necessary to strengthen the country's capacity to produce, connect, and specialize. First, intergovernmental transfers should become more transparent and predictable, considering factors such as population, fiscal capacity, infrastructure deficits, geography, and the varying costs of delivering comparable public services.

Second, Malaysia could establish Regional Development Compacts between the federal government and participating states, focusing on agreed economic objectives. For instance, a northern compact could coordinate semiconductor production, advanced manufacturing, water management, logistics, and talent development across Penang, Kedah, and neighboring areas.

A southern compact could address transport, manufacturing, logistics, and housing across interconnected economic corridors. Sabah and Sarawak would require arrangements that reflect their distinct constitutional positions, geography, and development requirements. Funding could then support agreed regional outcomes rather than isolated projects.

Federal incentives should also encourage states to cooperate when benefits cross borders. For example, Penang and Kedah could jointly develop technical training for semiconductor companies located in both states. Selangor and Negri Sembilan could coordinate industrial transport infrastructure. Regional logistics investments in Sabah and Sarawak could reduce supply-chain costs across multiple jurisdictions.

Projects that produce demonstrable cross-border spillovers should receive stronger federal support. This principle requires better measurement. Malaysia's national Input-Output tables show how industries purchase inputs from and supply outputs to one another, but conventional state GDP does not adequately reflect how production in one Malaysian region depends upon another.

Regional Input-Output analysis could reveal the extent to which Penang's electronics output relies on Kedah, how much of Sabah's economy purchases inputs from Peninsular Malaysia, and how much of Sarawak's industrial value remains within the state. It could also identify the largest leakages from domestic production chains. These questions are not academic; they determine whether an investment generates a broader Malaysian multiplier or remains an economic enclave.

The Statistics Department already records interregional merchandise trade between Peninsular Malaysia, Sabah, and Sarawak; however, a regional Input-Output analysis could provide deeper insights into the interdependencies among Malaysian states.