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Are the FDI inflow spillover effects on Malaysia's economic growth input
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 Economic Modelling 29 (2012) 1498–1504

Contents lists available at SciVerse ScienceDirect

Economic Modelling
journal homepage: www.elsevier.com/locate/ecmod

Are the FDI inflow spillover effects on Malaysia's economic growth input driven?
Elsadig Musa Ahmed
Faculty of Business and Law, Multimedia University, 75450 Melaka, Malaysia

a r t i c l e i n f o a b s t r a c t

Article history: This paper inspects the influence of human capital, labour force, and absorptive capacity, physical capital as a
Accepted 7 April 2012 control variable, foreign direct investment (FDI) inflows and gross domestic product (GDP) on Malaysia's
productivity growth. A time series quarterly data from the period of 1999 to 2008 was used. The effects of
Keywords: FDI inflows on human capital, labour force, absorptive capacity and physical capital were investigated. The
FDI inflows
Ordinary Least Squares (OLS) regression was applied to estimate the data in the first step and in the second
Economic growth
Input driven
step productivity indicators were calculated. The results show that the FDI inflows and inputs used are
Human capital negatively contributed to total factor productivity (TFP). Meanwhile, FDI plays a significant role in achieving
Absorptive capacity economic growth through input driven as indicated by the contribution of the TFP. In this regard, a significant
Malaysia positive relationship between human capital, labour force and absorptive capacity which determines the
spillover effect on Malaysian economic growth (GDP) was found and the physical capital has shown negative
relationship.
© 2012 Elsevier B.V. All rights reserved.

1. Introduction determining the knowledge based economy (K-economy) existence,

The Organisation for Economic Cooperation (OECD), 2002 stated
that the total benefits of FDI for developing economies are well docu-
mented. Given the appropriate host-country policies and a basic level
of development, a preponderance of studies show that FDI triggers
technology spillovers, assists human capital formation, contributes
to international trade integration, helps create a more competitive
business environment and enhances enterprise development. All of
these contribute to higher economic growth, which is the most potent
tool for alleviating poverty in developing countries. Moreover, beyond
the strictly economic benefits, FDI may help improve environmental
and social conditions in the host country by, for example, transferring
“cleaner” technologies and leading to more socially responsible corpo-
rate policies.
Additionally, the FDI inflows helps as a compound for speedy eco-
nomic growth experienced by East Asian countries by allowing these
developing countries to jump into the development stages and to
catch up with the western developed countries, it constitutes also
an important advocate for improved social norms. In this respect,
FDI plays a major role in the larger development agenda of the host
countries (Xiaolun, 2002). According to the author since the Golden
Age investment boom after World War II toward the East Asian eco-
nomic miracles in the 1980s, there is ample evidence to demonstrate
that investment is a key ingredient to sustained economic growth.
Moreover, according to Ramlee and Abu (2004), the investment
in human capital (knowledge workers) is a very critical factor in
E-mail addresses: elsadigmusa@yahoo.com, asadiq29@hotmail.com.
which is driven by human and technology knowledge, requiring a
high skilled and creative human capital to facilitate the K-economy
activities. In this respect, human capital theory views education and
training as an investment that can yield social and private returns
through augmented knowledge and skills for economic development
and social progress as stated by Schultz (1963). Furthermore, the
economic argument in favour of knowledge-based education and
training is linked to the perceived need of the global emerging K-
economy. That is based on the assumption that economic growth
and development currently are knowledge driven and human capital
is considered to be the centre of this development besides digital
technology in the form of information and communication technolo-
gy (ICT). But, the fact is that people will make the change, this ICT
could be used as a means to facilitate economic activities which
require human knowledge. Thus, the role of human capital is very
crucial in developing the innovation activities to turn them into
cutting products (knowledge products) and in this regard, the
K-economy is called innovation economy. Dahlman and Nelson
(1995) define national absorptive capacity as “the ability to learn
and implement the technologies and associated practices of already
developed countries”. National absorptive capacity is more than the
sum of the absorptive capabilities of domestic firms and includes
also the ability of human capital to develop new skills in general
and managerial skills in particular which could aid to develop the do-
mestic firms in a competitive manner.
Furthermore, the absorptive capacity in this study addresses how
the local people are benefiting to develop their skills through the
FDI inflows brought by multinational companies (MNCs) which locat-
ed their direct investment activities in their countries and used

0264-9993/$ – see front matter © 2012 Elsevier B.V. All rights reserved.
doi:10.1016/j.econmod.2012.04.010
 EM. Ahmed / Economic Modelling 29 (2012) 1498–1504
substantial economic, financial and technological incentives. More-
over, measuring the role of absorptive capacity in determining
whether domestic firms benefit from productivity spillovers from
FDI should be expressed in the productivity performance of these
economies. If the economy is showing technological progress, it
means that the economy has transferred the technology of MNCs to
domestic firms and has developed human capital capacity that can
be relied on to develop a productivity driven economy. This is called
as the spillover effect of FDI. Otherwise, it is considered to be an
input driven economy which uses the FDI inputs to produce output
without showing technical progress and less human capital skills
development.
1.1. FDI role in Malaysia's economic growth
Malaysia is the fourth most open economy in the world with ex-
ports and imports accounting for most of its total gross domestic
product (GDP). Trade was the lifeblood of the Malaysian economy.
FDI has long been its backbone. Economic openness has brought
much prosperity to this multi-racial country, as evidenced by the
rapid pace of economic growth and development since its indepen-
dence from Great Britain in 1957. It is noteworthy that the country's
per capita income now exceeds US$4,000 mark, placing Malaysia in
the league of the advanced developing economies. It is pertinent to
mention in passing that Malaysia is Australia's 10th largest trading
partner and that Australia is Malaysia's 14th largest trading partner
(Ariff, 2005).
Moreover, FDI has been hailed as the most important contributing
factor to Malaysia's phenomenal economic performance since the
1970s and is seen as the engine for growth, especially in the export-
manufacturing sector. Malaysia is one of the most favoured locations
of FDI. For example in 1995, Malaysia was the second largest recipient
of FDI among the Asian economies with a total amount of US$5.8
billion (UNCTAD, 1996). FDI has played a very important role in
shaping Malaysia's economy over its history. As the whole world is
becoming a global village, capital would move from one area to
another depending on the country, which offers the highest rate of re-
turn. Apart from returns from countries, other criteria that determine
the selection of FDI are; meeting the investors' needs in terms of good
financial practices and the ease of moving capital. The future growth
of the Malaysian economy will have to depend on the efficacy of
the various policies and measures enacted by the government in
order to realise her Vision 2020. More effort is now needed to attract
FDI due to intense competition from emerging economies such as
Thailand, Myanmar, Indonesia and China.
Furthermore, Oguci et al. (2002), state that FDI had assisted eco-
nomic growth in many Asian countries during the 1970s and 1990s.
For example, Malaysia actively accepted foreign investment to accel-
erate its economic growth during that period. One merit of FDI that
is often mentioned is technology transfer that accompanies new in-
vestments. Host economies expect direct productivity improvements
with FDI as well as indirect spillover effects. However, the results
of empirical studies on the effects of FDI on productivity are not
clear. For example, Oguchi (1994) compares production functions of
Korean and Japanese firms that were operating in the Masan free
trade zone and determined that Korean firms were more productive.
Ramstetter (1993) also finds that there was no significant difference
in the production functions of Thai local manufacturing firms and
foreign firms operating in Thailand. Lichtenberg and de la Potteries
(1996) examine the effects of FDI on productivity by cross section
analysis of 13 countries and did not find significant positive effects.
In contrast, Ramstetter compared foreign multinationals and local
firms in Asian countries and found that foreign multinationals tended
to rate higher than local firms in many characteristics (i.e. labour
productivity, capital deepening, capital productivity). Thus, empirical
results on the productivity effects of FDI are not conclusive.
1499
Meanwhile, there are various possible reasons for these seemingly
unexpected results. Young (1991) points out that when the FDI
requires adjustments in the host economy, including adjustment of
labour allocations and quality, it takes time to take full advantage of
the potential of new technology. On the other hand, Narayanan and
Guan (1994) examined technology transfer in the electrical and
electronics industries in Malaysia and find that, to have successful
technology transfer, the receiving country must be ready to absorb
new technology. In cases where labour is not ready for new technolo-
gy, improvement in productivity cannot be realised with FDI. Another
possible reason is that, in some cases, FDI might introduce technology
that is obsolete in the supplying economy and that is not necessarily
more productive than technology in the host country.
To close, following are some selected studies in Malaysian TFPG
which were based on growth accounting method. Starting with
Syrquin (1991) who found that in a study between 1960 and 1989,
the TFP growth (TFPG) contribution was 3% for 1960–1970 and 0.5%
for 1980–1989. In a similar study between 1970 and 1990, Kawai
(1994) found TFPG of 2.5% for 1970–1980 and 0.7% for 1980–1990.
Similarly, Gan and Soon (1998) in their study between 1974 and
1995 found TFPG contribution of 1.6% for 1974–1995 and 2.2% for
1990–1995 and between 1980 and 1997 Ab. Wahab (2004) found
that TFPG contribution of 1.3% for 1990–1997. While econometric
estimation studies of Wang and Thomas (1993) between 1960 and
1987 find that TFPG contribution is 2%, World Bank (1993) report be-
tween 1960 and 1990 found TFPG of 1.3%, and Gan and Robinson
(1993) study between 1975 and 1991 found that TFP was negatively
contributed during the first half of 1980 and positively contributed
after 1985. Likewise, between 1960 and 1990 as well as between
1978 and 1992 Zarina and Shariman (1994) also found that TFPG
has negatively contributed to Malaysia's economic growth. Therefore,
the above-mentioned studies that were based on econometric esti-
mation had a gap which had not shown the calculation of the
productivity indicator contributions and based their findings on the
estimated coefficients of explanatory variables used to satisfy only
the econometric requirements to validate and to reach homogenous
measures of the explanatory variables involved. On the other hand,
those studies that used growth accounting approach had calculated
the productivity indicators without providing econometric results to
show the reliability of the results generated.
Consequently, this study attempts to close these gaps by providing
statistical analysis which is lacking in the divisia translog index
approach (growth accounting) that is developed by Jorgenson et al.
(1987) and proposed a combined approach of econometric and growth
accounting approach to fill these two research gaps. This paper is
aiming to investigate the degree of FDI contribution to productivity
performance in Malaysia and to inspect whether this productivity is
based on FDI; is human capital and absorptive capacity contribution
productivity driven or input driven?
1.2. FDI spillover effects implications on sustainable productivity growth
According to Rajneesh (2004) productivity growth among develop-
ing countries relies considerably on the ability of their economic units
to acquire and internalise knowledge developed elsewhere if they are
to “catch up”. Laggard “economic units” (countries or firms) must
possess the ability to absorb, internalise and utilise the knowledge
potentially made available to them. This ability is known as “absorptive
capacity”, or the appropriate supply of human capital and technological
capability to be able to generate new technologies and consequently
use productive resources efficiently. In turn, this is expected to translate
into productivity growth for firms as well as countries. Accordingly,
absorptive capacity is significant for development because it permits
domestic economic actors to internalise knowledge that exists elsewhere
(either within the domestic economy or externally) that is made avail-
able directly or indirectly to them. The author further explains that the
1500 EM. Ahmed / Economic Modelling 29 (2012) 1498–1504
absorptive capacity per se has slight or no influence on productivity, eco-
nomic growth or employment. That is, it is an inactive concept – much
similar to an enzyme – that only has implication as a substance, serving
to metabolise. Technology flows could be embodied in FDI, intermediate
goods, capital equipment, or licensing, but may have little or no effect on
development or growth without absorptive capacity. This is expressed as
the interaction between technology inflows and spillover effect which
helps the entire firms and economy to develop their technology through
the domestic firms' products which are internationally competitive as in
the case of South Korea recently. In addition, Japan has achieved its in-
dustrial development within 30 years and has developed internationally
competitive firms, which had been achieved by the United States of
America (USA) within 70 years and Europe in double this period. Simply,
it is because the United Kingdom (UK) has introduced industrialization
process which flew to Europe, USA and the rest of the world. The spill-
over effect (absorptive capacity) which is the ability of the domestic
firms and human capital interaction with technology inflow is different
from country to country based on the human mentality and how it is
going to benefit from this trend and translate it into technological
progress (TFP) and to develop productivity driven economy in the form
of high quality technology and products that are able to compete in the in-
ternational arena. In this regard, Japan is considered to be a productivity
driven economy followed by South Korea, while, other East Asian econo-
mies are considered to be input driven as they unsuccessfully failed to
translate the spillover effect of FDI to demotic technology that should
help the domestic firms to translate it into internationally competitive
products and investment capital.
Additionally, Kneller and Stevens (2002) investigate whether
differences in absorptive capacity (spillover effect) help to explain
cross country differences in the level of productivity. Absorptive
capacity, as discussed in the literature by Arrow (1969), captures the
idea that countries may differ in their effort and ability to adopt new
technologies even if knowledge is global (Eaton and Kortum, 1999;
Griffith et al., 2000; Papageorgiou, 2000; Xu, 2000). Two formal ap-
proaches have been developed to model this mechanism: Abromovitz
(1986) and Cohen and Levinthal (1989) model technical adoption as
depending on the level of human capital, whereas Fagerberg (1994)
and Verspagen (1991) develop models in which innovation improves
the capacity to absorb foreign country technology. The most important
factor in technology transfer is the human factor which explains the
differences in the level and concept of productivity by accessing to the
same technology brought by FDI. Meanwhile, the benefit from absorp-
tive capacity (spillover effect) is accordingly.
Moreover, Alfaro et al. (2009) had stated that in the macroeco-
nomics empirical literature's weak support for an exogenous positive
effect of FDI on economic growth was originated. Moreover, the
findings in this literature indicate that a country's capacity to take
advantage of FDI externalities might be limited by local conditions,
such as the development of local financial markets or the education
level of the country, i.e., absorptive capacities. Borensztein et al.
(1998) showed that the FDI investment brings technology transfer
and translated it into higher economic growth only when the host
country has a minimum threshold of stock of human capital. Further,
Alfaro et al. (2004) provide evidence that only countries with well-
developed financial markets gain significantly from FDI in terms
of their growth rates. These findings are consistent with the reality
of East Asian nations as Japan and South Korea benefited from
foreign technology investment through technology transfer and
human capital skills development.
In terms of the microeconomics, empirical evidence of spillover ef-
fects of FDI, Alfaro et al. (2009) demonstrate that most of the studies
using firm level panel data found that there was no effect of foreign
presence or resulted in a negative productivity spillover effect from
multinational enterprises (MNEs) to the developing countries' firms.
Meanwhile, the positive spillover effects were found only for devel-
oped countries including those from East Asian nations. Based on
these negative results, a new generation of studies argued that subse-
quent multinationals would like to prevent information leakage to
potential local competitors. Nevertheless, to benefit from knowledge
spillover to their local suppliers, FDI spillover ought to be between
different industries. Hence, one must look for vertical (intra-industry)
externalities instead of horizontal (inter-industry) externalities. In
this regard, the externalities from FDI would patent themselves
through forward or backward linkages, i.e., acquaintances among
domestic suppliers of intermediate inputs and their multinational
clients in downstream sectors (backward linkage) or between foreign
suppliers of intermediate inputs and their domestic clients in up-
stream sectors (forward linkage). Evidence was provided from the
studies undertaken by Javorcik (2004) and Alfaro et al. (2004); for
instance, those studies bargain evidence for the existence of back-
ward linkages between the downstream suppliers and MNEs in
Lithuania; and Venezuela, Chile, and Brazil, respectively. Moreover,
paralleling the macroeconomic evidence, the study under taken
by Villegas-Sanchez (2009), who has used firm level data from
Mexico, showed that domestic firms only experience productivity
increases from FDI if they were situated in financially developed
regions. Meanwhile, in addition the author showed that domestic
firms located in regions where access to the credit was more prob-
lematic would experience a negative spillover effect from FDI.
2. Methodology and estimation procedures
The paper attempted to modify the conventional growth account-
ing framework as utilised by Stigler (1947), Abramovitz (1956),
Kendrick (1956), and Solow (1956, 1957), which was finally brought
to fruition by Kendrick (1961) and further refined by Denison
(1962), Denison and Edward (1979), Griliches and Jorgenson
(1962), Jorgenson et al. (1987) and Elsadig (2006, 2007, 2008). The
production of the economy is expressed as a function of aggregate
physical capital, labour, human capital, FDI, Absorptive Capacity
(FDI ∗ School) and time. This approach provides more room for decom-
position of contributions of factor inputs and technological change to
economic growth.
The production function for economy can be represented as
follows:
GDP ¼ FðK;L;HC; FDI;AC; TÞ ð1Þ
where aggregate output, gross domestic product (GDP) is a function
of aggregate physical capital input (K), labour input (L), human
capital (HC), foreign direct investment (FDI), absorptive capacity
(AC) and time T, that proxies for total factor productivity growth
(TFPG) as a technological progress of the Malaysian economy and
indicator of spillover effects.
The divisia index basically decomposes the output growth into the
contribution of changes in inputs (such as aggregate physical capital,
labour, human capital, FDI and absorptive capacity growth), and
TFPG. In other words, considering the data at any two discrete points
of time, say T and T-1 the growth rate of aggregate output (GDP) for
an economy can be expressed as a weighted average of the growth
rates of aggregate physical (K), labour (L), and FDI plus a residual
term typically referred to as the rate of growth of TFP. Hence the
TFPG of the economy is computed as the difference between the
rate of growth of aggregate output and weighted average of the
growth in the aggregate physical capital, labour, FDI and absorptive
capacity where the weights are the respective shares of each input
in the economy's aggregate output.
According to Mahadevan (2001), the TFPG studies on the Malaysian
manufacturing sector have used the nonparametric translog-divisia
index approach developed by Jorgenson et al. (1987). This approach
does not require the explicit specification of a production function,
but the major drawback is that it was not based on statistical theory
 EM. Ahmed / Economic Modelling 29 (2012) 1498–1504
and, hence, statistical methods could not be applied to evaluate their
reliability, thus casting doubts on their results. The present study at-
tempts to close this gap by developing this model into a parametric
model and providing statistical analysis for it in the first step as follows:
lnGDPT ¼ a þ α: lnKT þ β: lnLT þ θ: lnHCT þ λ: lnFDIT
ð2Þ
þφ: lnACT þ εT T ¼ Q 1 1999  Q 4 2008
where
α is the output elasticity with respect to physical capital
β is the output elasticity with respect to labour
θ is the output elasticity with respect to human capital
λ is the output elasticity with respect to FDI
φ is the output elasticity with respect to absorptive capacity
a is the intercept or constant of the model 1
εT is the residual term 2
ln is the natural log to transform the variables.
The intercept (a) has no position in the calculation of the produc-
tivity indicators contribution. Consequently, a second step was pro-
posed, which calculates the contribution of productivity indicators
that is transforming Eq. (2) as
Δ lnTFPT ¼ Δ lnGDPT −½α:Δ lnKT þ β:Δ lnLT þ θ ::Δ lnHCT ð3Þ
þλ:Δ lnFDIT þ φ ::Δ lnACT 
where the weights are given by the average value shares as follows:
Δ lnGDPT is the growth rate of output
α:Δ lnKT is the contribution of the physical capital.
β:Δ lnLT is the contribution of the labour
θ ::Δ lnHCT is the contribution of the human capital
λ:Δ lnFDIT is the contribution of the FDI
ϕ ::Δ lnACT is the contribution of the absorptive capacity
Δ lnTFPT is the total factor productivity growth
Δ is the difference operator denoting proportionate change rate.
Accordingly, the framework decomposes growth rate of aggregate
output into the contributions of the rates of growth of the aggregate
physical capital, labour, human capital, FDI and absorptive capacity,
plus a residual term typically referred to as the rate of growth of TFP.
3. Data sources
Secondary data had been collected to be used in this study. In
this regard, the secondary data were the data that were collected
neither directly by the user nor specifically for the user, often under
conditions not known to the user. It may be available from internal
sources, or might have been collected and published by another
organisation. The advantages of secondary data are that it is cheap
and inexpensive and is easily accessible and available for the public
use. Furthermore, it saves time and efforts and totally unobtrusive.
It avoids data collection problems and it provides a basis for compar-
ison. The secondary data normally could be found in various govern-
ments and international research institutions' statistical websites.
The secondary data used in this study is assumed to be reliable be-
cause it was prepared and published by the Department of Statistics
in Malaysia. On the other hand, the disadvantages of the secondary
data were related to the credibility of the source who has published
1
The intercept term, as usual, gives the mean or average effect on dependent vari-
able of all the variables excluded from the model.
2
The residual term proxies for the total factor productivity growth that accounts for
the technological progress of the economy through the quality of input terms.
1501
this data and the small shades that may not fit into our research
objectives. Another disadvantage can be that the data might be out-
dated. Similarly, we have no control over the quality of the data and
would not know how authentic are the measures used for data
collection.
Meanwhile, the data for this study has been collected from the
Department of Statistics of Malaysia in the form of quarterly period
of Q1 1999 to Q4 2008, of the output was quarterly real GDP and
the inputs are physical capital, (gross capital formation as a share of
GDP), number of labour force (number of employed persons), real
FDI inflows and the school enrolment that is representing (human
capital) as a proxy and absorptive capacity (FDI*SCHOOL) which is
representing the interaction variable .between FDI and human capital
(absorptive capacity).
4. Results and discussion
This section demonstrates the results of the unit root test con-
ducted in this study and the coefficients obtained by applying OLS
to the data by using Eq. (2). In this regard, based on Table 1, the result
of the unit root test indicates that almost all of the variables are non-
stationary in their respective levels. While, in the first differencing on
the variables, the null hypotheses of a unit root in the Augmented
Dickey Fuller tests were rejected at the 1% significance level. Therefore,
since all the variables have to be differenced once to obtain stationarity,
it is integrated of order 1 which enables us to proceed with the rest of
the economic model. Referring to Engle and Granger (2003), if the vari-
ables have occurred in first differences instead of levels, the difficulties
of non-stationary variables could be avoided since the differenced vari-
ables are normally stationary even if the original variables are not as
explained by Elsadig (2006).
Moreover, based on Table 2, the result implies that, the coeffi-
cients of the effects of foreign direct investment (FDI) as both variable
and as proxy showed the interaction variable (FDI ∗ SCHOOL) that is
used as a proxy for absorptive capacity in order to know the degree
of spillover effect, school enrolment to take into account human
capital and labour force, indicating a positive effect on Malaysian
economic growth.
However, from the result, physical capital shows a negative
relationship on Malaysian economic growth. The R² in this model
is 0.85366, which explains that 85% of the total differences in the
amount of gross domestic product (GDP) can be explained by the
changes of the independent variables, which are human capital,
physical capital, absorptive capacity and labour force. Furthermore,
the adjusted R² 0.83693 takes into account the sample size and the
number of independent variables included in the regression equation.
Table 1
Augmented Dickey–Fuller coefficients, Q1 1999–Q4 2008.
Level First difference
Variable Trend and Intercept Trend and Intercept
intercept intercept
Physical − 1.851 (2) − 0.977 (2) − 9.056 (1)*** − 9.178 (1)***
capital
FDI − 3.974 (4)** − 2.239 (4) − 13.447 (0)*** − 13.447 (0)***
FDI human − 3.940 (4)** − 2.867 (1)* − 13.330 (0)*** − 12.911 (0)***
capital
GDP − 10.831(5)** − 0.516 (6) − 4.585 (4)*** − 4.744 (4)***
Human − 6.877 (0)*** − 0.372 (2) − 10.120 (0)*** − 6.900 (1)***
capital
Labour force − 4.914 (0)*** − 1.838 (1) − 11.525 (0)*** − 11.393 (0)***
Figures in the table were estimated by using the original data
Asterisk ***, **, and * denote 1%, 5%, 10% respectively. Figures in parentheses are the lag
lengths. The asymptotic and finite sample critical values for ADF are obtained from
MacKinnon (1996). ADF test examine the null hypothesis of a unit root against the
stationary alternative.
1502 EM. Ahmed / Economic Modelling 29 (2012) 1498–1504

Table 2 Particularly, in the pick flow of foreign direct investment to

Estimated coefficients of Malaysian economy, Q1 1999 − Q4 2008. Malaysian economy, the TFPG contribution was very low or negative
Variables Coefficients t-Statistic Prob. and that was observed during the period of structural transformation
in Malaysian economy in 1987. The economy grew very fast based on
C − 31.95784 − 6.665074 0.0000
LABSORPTIVE 0.049329 1.228194 0.2276 FDI that supported the manufacturing sector to become the engine
LPHYCAPITAL − 0.194723 − 1.800798 0.0804 of growth of Malaysian economy during this period. The negative
LHUMANCAPITAL 0.797493 0.833973 0.4100 productivity growth of Malaysian economy which has been shown
LLABOURFORCE 4.132359 3.519926 0.0012
through the negative contrition of TFPG during the period of this
FDI 0.193961 3.228078 0.0026
study could be explained by the fact that this period is considered
R-squared 0.853656 being the period of post Asian financial crisis. During this period FDI
Adjusted R-squared 0.836930 flew out of Malaysia and reduced so much. By comparing TFPG contri-
F-statistic 51.04044 bution rates of this study with previous selected studies in Malaysia,
Prob (F-statistic) 0.000000
this study found that TFPG contribution rates are consistent with
Figures in the table were estimated by using Eq. (2). most of the previous studies as demonstrated in the introductory
part of the paper; the TFPG of Malaysia contribution was very low
or negative. Additionally, the findings of this study are very consistent
4.1. Productivity indicators contribution with the studies of Zarina and Shariman (1994), who found that TFPG
of Malaysia was negative during 1978–1992 and Gan and Robinson
Analysis was carried out to compare the productivity indicators of (1993) found that TFPG was negative during the first half of 1980
quarterly period of Q1 1999 to Q4 2008, of the output is quarterly and positive after 1985.
real GDP and the inputs are gross real capital formation, number of Meanwhile, the highest contribution of GDP to the productivity
labour force (number of employed persons), real FDI inflows and the growth (input driven) of the Malaysian economy by including human
school enrolment that is representing (human capital) as a proxy and capital, FDI inflows and absorptive capacity (FDI∗ SCHOOL) that is
absorptive capacity (FDI∗ SCHOOL) which represents the interaction representing the interaction variable between FDI and human capital
variable between FDI and human capital (absorptive capacity) within (absorptive capacity) which includes the traditional factors of produc-
the Malaysian economy for the entire period of Q1 1999 Q4 2008. tion in the model resulted in negative contribution of TFPG (Table 3).
Moreover, the use of total factor productivity overcomes the problems This period of the study was found to be the period of post Asian finan-
of single productivity indicators such as labour productivity and capital cial crisis of 1997 and the period that followed it. The performance of
deepening by measuring the relationship between output and its total the Malaysian economy was very low compared with the period after
inputs (a weighted sum of all inputs), thereby giving the residual out- the transformation of Malaysian economy into an exported-oriented
put changes not accounted for by total factor input changes. Being a re- one. The TFPG contributed negatively and the GDP was the highest
sidual, changes in TFP are not influenced by changes in the various one to contribute to the economy's input driven productivity growth
factors which affect technological progress such as the quality of factors with no technological progress that must show the positive effects the
of production, flexibility of resource use, capacity utilisation, quality of FDI inflows in terms of technology transfer and skills upgrading the
human capital and management, economies of scale, and so on and so human capital through training and retraining or what is so called
forth (Rao and Preston, 1984). learning by doing. This study found that the reasons behind input
Therefore, the improvement and slowdown of TFP contribution to driven contribution were the financial crises of 1997 that reduced FDI
Malaysian economy in terms of average annual growth rates are inflows and flew out Malaysia, besides the quality of human capital
dependent on the quality of the inputs used in the production of the and the technology involved in the production of the economy.
economy, that were reported to be of low quality and insufficient. Moreover, the contribution of aggregate physical capital to GDP
As a result of low quality inputs involved in Malaysian economic in terms of average annual productivity growth of the Malaysian
activities, the contribution of TFPG to the Malaysian economy in economy was considered to be high in the form of input driven, not
terms of average annual productivity growth by including human productivity driven as observed in the negative contribution of
capital, FDI inflows and absorptive capacity (FDI ∗ SCHOOL) which TFPG that indicated the quantity of capital that contributed to high
represents the interaction variable between FDI and human capital GDP growth, not the quality of the capital that was contributed
(absorptive capacity) in the model was negative (Table 3). On the negatively to TFPG. Likewise, the contribution of aggregate labour to
other hand, the contribution of physical capital, human capital FDI GDP in terms of average annual productivity growth of the Malaysian
inflows and absorptive capacity has improved Malaysian productivity economy was positive (Table 3), but, it has contributed negatively to
growth as an input driven economy and not productivity driven econ- TFPG. Again, it is the quality of labour which is considered being low
omy based on the negative contribution of TFPG which is considered due to the fact that Malaysia's economy is dominated by unskilled
as the technological progress of the economy through the quality of and semi-skilled labour and is facing shortage of labour.
inputs used, not the quantity of them that is considered input driven Furthermore, the contribution of the human capital, FDI and ab-
by using more inputs to produce output. sorptive capacity used in the economy was as high as the contribution
of physical capital and labour. By examining the role of human capital,
FDI and absorptive capacity to achieve productivity driven economy
Table 3
through TFPG contribution, it was found from the results that
Productivity indicators of Malaysian economy, Q1 1999–Q4 2008, %. there was a negative contribution of these variables to TFPG of the
Malaysian economy (Table 3). This indicates the input driven produc-
Productivity indicators %
tivity of Malaysia's economy through the quantities of these inputs
TFPG − 31.95 and not their qualities that resulted in positive contribution of TFPG
GDP 11.52
that is so called productivity driven which shows how the economy
Physical capital 9.863
Labour 9.201 is technologically progresses and humanely develops new skills
FDI 8.154 resulting in high products in terms of quality and quantity, thus
Human capital 8.632 firms are able to compete in the global investment.
Abortive capacity 9.879 Finally, the results of this study have shown that the productivity
Figures in the table were calculated using Eq. (3). growth of Malaysia's economy is not input driven but rather, productivity
 EM. Ahmed / Economic Modelling 29 (2012) 1498–1504
growth driven and is based on quantity and not the quality of inputs once
the results of TFPG contribution were compared. The findings of this study
are consistent with the studies undertaken by Lall (1995), as he states that
it is in other Asian newly industrialised countries where their productivity
was input driven and as in the statements of Young (1992, 1995) and Kim
and Lau (1994). In this respect, Sarel (1996) expressed his concerns that
some East Asian countries might face the same fate as the Soviet Union's.
This was because these countries had invested primarily in labour and
capital rather than in technology over the past few decades and there
was no real technology transfer and much human capital development
that could sustain the progress of the industrial development That is
called in this study the spillover effects of FDI investment.
5. Conclusion and policy implications
Foreign direct investment (FDI) plays a significant role in Malaysia's
economic growth from the hyper markets to electronics and electrical
investment. This paper analyses the effects of FDI inflow investment
in Malaysian economic growth in terms of GDP and other productivity
indicators. In this respect, the econometric result as the first step of the
analysis has shown that there is a positive relationship between human
capital and absorptive capacity, those tested to know the level of the
spillover effects on GDP. Whereas, the influence of the physical capital
on Malaysia's economic growth in terms of GDP growth was found to
be negative and unidirectional runs were found from FDI to GDP.
Moreover, this paper showed that human capital, technology
spillover effects and labour force provide the potential effects of FDI
to enhance the Malaysian economic growth as an input driven
economy. Meanwhile, the contribution of human capital offers the
strongest evidence in influencing GDP. In addition the MNEs have
played a major role in bringing economic development and employ-
ment to Malaysia and many parts of the world.
Furthermore, the FDI inflows generate the possible spillovers of
technology and knowledge (that determine by the level of absorptive
capacity) through the interaction of technology knowledge and local
human capital to upgrade their skills and firms to transfer the technol-
ogy to the economy. This spillover effects might be able to improve the
Malaysian firms and human capital development to contribute signif-
icantly to Malaysia's economic growth. As expected the production
supported by advance technology will educate the skilled labour and
eventually improved the productivity and enhance the economic
growth to be productivity driven growth that must show technical
progress through TFP contribution.
However, the abovementioned econometric result has a gap of not
providing the productivity indicators and it was only based on the
coefficients of the quantities of inputs used. This is showing the
homogenous measures of these variables as these were based on
different measures. To fill this gap and the gap of growth accounting
approach that has doubt in its result of not providing statistical
measures to show its reliability. This paper has taken a second step
by plugging the coefficients obtained in the modified model to calcu-
late the productivity indicators used in this study. This includes the
growth rate of GDP, physical capital, labour force, human capital,
FDI and absorptive capacity contributions, which are considered to
be input driven indicators. Besides, the calculation of TFP which is
indicated as the combined contribution of quality of the factors of
production and an indicator of the technological progress that is
showing the spillover effects that must transfer the technology to
the hosting economy and upgrade the skills of its human capital,
which is called productivity driven.
Meanwhile, based on TFPG results of this paper, the Malaysian
economic growth is considered to be input driven and highly depen-
dent on FDI investment. This is indicating that the FDI spillover effects
had insignificant impact on Malaysian economy, that was taken place
on developed nations in general and in Japan and South Korea in
particular. To achieve the new economic model goals in turning the
1503
Malaysian economy to be a high income and knowledge driven econ-
omy by 2020, the quality of the workforce (human capital) will make
the difference in creating productivity driven economy. The human
factor plays an essential role to interact with the technology to create
cutting edge technology and to facilitate the economic activities to
create new values to make the difference in the Malaysian economic
fundamentals. This is what so called the FDI spillover effects. Finally,
the concept of one Malaysia will become reality if the Malaysian pu-
pils integrated in one national school system instead of the current
race based schools.
Acknowledgements
A special thank goes to Nur Hamizah Mohamed Azmi for her role
in collecting and analysing the data used in this study, to the referees
and the Economic Modelling Chief editor for the useful comments
that improved the paper significantly.
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