Report No. 131 h3 -MiY Malaysia Meeting Labor Ne'eds: More Workers and lKeUr ;I\dii Februars 2B, 19995 ( Xlrllls I)t d i- [)i% i -, I G LIII II III j.t 'l ' ' w>.1., ! ;iwt 1'<1 III( R,-wl,,i Document of the World Bank CURRENCY EQUIVALENTS Currency unit = Ringgit Average 1994 - US$1.0 = M$2.6242 M$1.0 = US$0.3811 Average 1993 - US$1.0 = M$2.5741 M$1.0 = US$0.3885 Average 1992 - US$1.0 = M$2.5474 M$1.0 = US$2.7501 Average 1991 - US$1.0 = M$2.750 M$1.0 = US$0.364 Average 1990 - US$1.0 = M$2.705 M$1.0 = US$0.370 Average 1989 - US$1.0 = M$2.709 M$1.0 = US$0.369 Average 1988 - US$1.0 = M$2.619 M$1.0 = US$0.382 Average 1987 - US$1.0 = M$2.520 M$1.0 = US$0.397 Average 1986 - US$1.0 = M$2.581 M$1.0 = US$0.387 Average 1985 - US$1.0 = M$2.483 M$1.0 = US$0.403 GLOSSARY OF ABBREVIATIONS AFP Chile's funds AFTA ASEAN Free Trade Area ASEAN Association of South-East Asian Nations ATP Approved Training Program CIAST Centre for Instructors and Advanced Skill Training CO Contacts Overseas DDI Double Deduction Incentive for Training DDIT Double Deduction Incentive for Training EPF Employees Provident Fund EPU Economic Planning Unit EU European Union FDI Foreign Direct Investment FELDA Federal Land Development Authority FLPR Female Labor Force Participation Rate FMI French-Malaysia Institute GDP Gross Domestic Product GMI German-Malaysia Institute GOM Government of Malaysia HIV Human Immunodeficiency Virus HRDC Human Resource Development Council HRDF Human Resources Development Fund ID Immigration Department IKK Institut Ketukangan Kementah IKM Institut Kemahiran Mara ITI Industrial Training Institutes LA Local Agent LC Labor Contractors MHR Ministry of Human Resources MIDA Malaysian Industrial Development Authority MTUC Malaysian Trade Union Congress NEP New Economic Plan NGOs Non-Governmental Organizations NPC National Productivity Corporation NUPW National Union of Plantation Workers NVTC National Vocational Training Council NWC National Wages Council OECD Organization for Economic Cooperation and Development RM Malaysian Ringgits RRIM Rubber Research Institute of Malaysia SBL Skim Bantuan Latihan SMV Secondary Vocational Schools of the Ministry of Education TFP Total Factor Productivity TNA Training Needs Analysis UPAM United Planting Centers VITB Vocational and Industrial Training Board YTC Youth Training Centers MEZTING LABOR NEEDS: MORE WORKERS AMD BETTBR SKILLS Country Economic Report Table of Contents Page No. Executive Summary . . . . . . . . . . . . . . . . . . . . . . i I. Malaysia's Tight Labor Market . . . . . . . . . . . . . . . . . 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . 1 A. Emerging Trends in the Labor Market . . . . . . . . . . . . 3 B. The Wage Pattern and Investment . . . . . . . . . . . . . 16 Appendix la: Estimates of Labor Supply and Demand . . . . 25 Appendix lb: Investment Rates and Skilled Wages . . . . . 28 II. Nonwaae Costs of Labor . . . . . . . . . . . . . . . . . . . 32 Introduction . . . . . . . . . . . . . . . . . . . . . . 32 A. Social Security and Other Payroll Levies . . . . . . . . 34 B. Fringe Benefits .... . . . . ..... . . . . . . . . 41 C. Work Incentives, Unions and Employment Flexibility . . . 47 III. Augmenting the Labor Force, The Role of Migration . . . . . . 58 Introduction . . . . . . . . . . . . . . . . . . . . . . 58 A. Immigration: Stocks and Flows . . . . . . . . . . . . . . 58 B. Benefits and Costs of Immigration Workers . . . . . . . . 63 C. Immigration Policies . . . . . . . . . . . . . . . . . . 74 D. Emigration: Stocks and Flows . . . . . . . . . . . . . . 82 E. Regional Approaches to Trade and Migration . . . . . . . 85 F. Recommendations . . . . . . . . . . . . . . . . . . . . . 85 IV. Industrial Skills Training . . . . . . . . . . . . . . . . . 88 A. Introduction .... . . . . . . . . . . . . . . . . . . 88 B. Supply-side Issues in Industrial Skills Training . . . . 89 c. Demand-side Incentives for Training . . . . . . . . . . . 103 Appendix a: Estimating the Labor Market outcomes of Public training ................... . 125 Appendix b: The DDIT Scheme . . . . . . . . . . . . . . . 128 Appendix c: A Preliminary Analysis of the HRDF . . . . . 129 References Chapter II . . . . . . . . . . . . . . . . . . . . . . . . . 134 Chapter III . . . . . . . . . . . . . . . . . . . . . . . . . 135 This report has been prepared by Ijaz Nabi (EAlCO, Mission Leader), Indermit Gill (ESP), Jeffrey Hammer (EAPVP), Hong Tan (PSD), Judy Lu, Sintamei Tameno (EAlCO) and consultant Philip Martin. The Government of Malaysia's support during the mission in March-April 1994 is gratefully acknowledged. The report was discussed with the Government in September 1994. Text Tables Pace No 1.1 Employment by Sector, 1987-1993 . . . . . . . . . . . . . . . . 2 1.2 Simple Growth Accounting in Malaysia . . . . . . . . . . . . . 3 1.3 Ratio of Skilled to Total Workers . . . . . . . . . . . . . . . 8 1.4 Percentage Change in Wages of Different Categories of Workers 1987-91 .... . . . . . . .... . . . . . . . . . . . 10 1.5 Total Labor Force Participation Rates . . . . . . . . . . . . 12 1.6 Trends in Sectoral Employment, Malaysia . . . . . . . . . . . 15 1.7 Comparative Trends in Sectoral Employment . . . . . . . . . . 15 1.8 Determinants of Future Japanese Investment in East Asia's Manufacturing Sector ....... ........... . 19 1.9 Operational Impediments by Japanese Affiliates in East Asia . 19 1.10 Labor Costs and Increases, 1992 . . . . . . . . . . . . . . . 20 1.11 Ease of Recruiting Skilled Labor . . . . . . . . . . . . . . 20 1.12 Japan's FDI in East Asia . . . . . . . . . . . . . . . . . . 21 1.13 Taiwan (China)'s FDI in East Asia, 1989-93 . . . . . . . . . 22 1.14 Gross Enrollment Ratios (t) by Level of Education, Asia 1970-1985 ..23 1.15 Proportion of Federal Subsidy on Education Received per Quintile of Household per Capita Income . . . . . . . . . . 24 lA.l Labor Supply and Demand Estimates . . . . . . . . . . . . . . 29 1A.2 Supply Estimates: Disaggregated Labor Categories . . . . . . 30 1A.3 Investment Equations .31 2.1 Nonwage Costs Proportional to Wages, Various Sectors . . . . 36 2.2 Differences in Tax Base for Various Payroll Levies . . . . . 37 2.3 Sectoral Differences in EPF Coverage . . . . . . . . . . . . 39 2.4 Nonproportional Nonwage Benefits Under Employment Act, 1995 . 43 2.6 Total Bonuses Paid, By Occupational Category . . . . . . . . 51 2.7 Bonuses, Union Membership, and Labor-Management Relations in Three High-Performing Asian Economies . . . . . . . . . . . 53 Al Determinants of EPF Contributions, 1961-1993 . . . . . . . . 55 A2 Determinants of Bonuses .56 A3 Propensity to Adopt Flexi-Wage Systems . . . . . . . . . . . 57 3.1 Estimated Immigrant Workers in Malaysia by Sector in 1991 59 3.2 Estimated Immigrant Workers in Malaysia by Sector in 1993 60 3.3 Some Wage Differentials Between Indonesia and Malaysia . . . 62 3.4 Estimated Immigrant Contribution to GDP: 1993 . . . . . . . . 65 3.5 Malaysian and Non-Malaysian Workers in Manufacturing: 1981-1991 . . . . . . . . . . . . . . . . . . . . . . . . . 64 3.6 The Process for Recruiting Legal Foreign Plantation Workers (Pre-1992) ..76 3.7 Illegal Aliens Apprehended in Malaysia between July 1, 1992 and October 31, 1993 ..79 3.8 Work Permits Issues by Sector: December 1991-93 . . . . . . . 79 Page No. 3.9 Immigrant Workers Requested and Certified: March 1992- December 1993 . . . . . . . . . . . . . . . . . . . . . . . 81 4.1 Output of Skilled Manpower by Education and Training Institutions . . . . . . . . . . . . . . . . . . . . . . . 90 4.2 Output of Skilled Manpower-Public Training Institutions . . . .90 4.3 Numbers Taking Trade Tests and Pass Rates . . . . . . . . . . 95 4.4 Summary Data on Labor Market Outcomes by Training Institutions. .......... 97 4.5 Predicted Labor Market Outcomes From Regression Analysis . . 99 4.6 Employment Size Distribution of DDIT Applicants . . . . . . . 113 4.7 Summary Data on Operation of the HRDF Schemes . . . . . . . . 116 4.8 Distribution of ATP and SBL Trainees by Type of Training . . 121 4A.1 Probability of Working & Monthly Starting Pay . . . . . . . . 126 4A.2 Time to Find Job and Training Relevance to Job . . . . . . . 127 4B.1 Summary Statistics on DDIT Approved Programs 1988-1993 . . . 128 4C.2 Number and Distribution of Companies and Workers Registered with HRDF by Company Size and Industry . . . . . 130 4C.3 Percent of Companies Training under SBL and ATP Scheme by Company Size and Industry . . . . . . . . . . . . . . . 130 4C.4 Number and distribution of Trainees - SBL and ATP Schemes by Company Size and Industry . . . . . . . . . . . . . . . 131 4C.5 Number of Workers Trained in SBL Scheme by Type of Training . 132 4C.6 Distribution of types of SBL Training by Industry . . . . . . 133 Text Fiaures 1.1 Private Sector Real Wage . . . . . . . . . . . . . . . . . . . 4 1.2 Wages as Share of Costs and Value Added . . . . . . . . . . . . 5 1.3 Unit Cost of Labor of Top Five . . . . . . . . . . . . . . . . 6 1.4 Skill Intensity ......... ... 7 1.5 Trends in Gender Inequality in Earnings . . . . . . . . . . . 12 1.6 Female Labor Force . . . . . . . . . . . . . . . . . . . . . 13 1A.1 Employment . . . . . . . . . . . . . . . . . . . . . . . . . 27 2.1 Nonwage Costs as a Fraction of Wages . . . . . . . . . . . . 33 2.2 Firms Offering Fringe Benefits, 1993 . . . . . . . . . . . . 46 2.3 Share of Women in Incremental Employment, All occupations 46 2.4 Share of Women in Incremental Employment, Various Countries 47 2.5 Firms Using Incentive Schemes, 1993 . . . . . . . . . . . . . 52 Al Nonwage Costs as a Fraction of Wages . . . . . . . . . . . . 54 A2 Turnover in Firms, June '92 to May '93 . . . . . . . . . . . 54 Page No. 3.1 Average Annual Earnings for All Mfg and Wood and Cork Workers: 1981-1990 . . . . . . . . . . . . . . . . . . . . 67 3.2 Unit Labor Costs and Capitol-Labor Ratios for All Mfg and Wood and Cork, 1981-100 . . . . . . . . . . . . . . . . 67 3.3 Unit Labor Costs and Capitol-Labor Ratios for All Mfg and Wood and Cork, 1987=100 . . . . . . . . . . . . . . . . 69 3.4 Average Annual Earnings in Selected Services: 1987-1991 . . . 69 3.5 Unit labor Costs and Capitol-Labor ratios for Road haulage and all Services, 1987=100 ..70 3.6 Employer-Reported Plantation Labor Shortages in Malaysia 1980-1991 ..71 3.7 Paid Workers Employed in Construction at the End of the Year: 1981-1991 ..73 3.8 Illegal Aliens who Registered in Malaysia between December 1, 1991 and June 30, 1992 . . . . . . . . . . . . . . . . . 78 3.9 Foreign Workers Issued Work permits, Requested by Employers, and Certified: December 1991-93 . . . . . . . . . . . . . . 81 3.10 Immigration to the United States from Malaysia and Asia 1982-100 ..84 4.1 Numbers Taking and Passing . . . . . . . . . . . . . . . . . 92 4.lb Pass Rates on the MLVK Trade Tests by Training Institution . 96 4.2 Actual and predicted Percent . . . . . . . . . . . . . . . . 100 4.2b Other Observed and Predicted . . . . . . . . . . . . . . . . 100 4.3a Proportion of Firms Training . . . . . . . . . . . . . . . . 105 4.3b Percent Training by Sub-sector . . . . . . . . . . . . . . . 105 4.4a Product Range, New Technology . . . . . . . . . . . . . . . . 106 4.4b By Sub-sector . . . . . . . . . . . . . . . . . . . . . . . . 106 4.5a DDIT Program Applications ................. . 110 4.5b DDIT Trainees by Training Type . . . . . . . . . . . . . . . ill 4.6a Percent Takeup of SBL and ATP . . . . . . . . . . . . . . . . 118 4.6b Takeup of SBL and ATP ................... . 119 Text Boxe 2.1 Chile's Provident Fund: The Superiority of Private Management . . . . . . . . . . . . . . . . . . . . . . . . 40 MALAYSIA MEETING LABOR NEEDS: MORE WORKERS AND BITTER SKILLS Executive Summary 1. Malaysia is unique among developing countries in that in a relatively short period from 1987 to 1993, the labor market has changed dramatically and the perennial preoccupation with unemployment has given way to problems of serious labor shortages. The Government's policy stance towards the labor market needs to adjust to this successful transition of the economy. To remain attractive in an intensely competitive region, the Government must shift its traditional focus from job creation to the more complex initiatives aimed at relieving labor market tightness through immigration, greater female participation in the labor force and upgrading the quality of labor. The objective of this report is to assist the Government in strengthening these initiatives by identifying bottlenecks in the labor market and suggesting remedies in light of international experience. 2. The dilemma faced by Malaysia is that, given the small population base, rapid GDP growth quickly translates into high labor costs. Rising wages, when productivity is also rising, are a welcome reward to workers. However, if productivity lags behind wage increase, the economy's international competitiveness is lowered. The policy choices to maintain internationally competitive labor costs are: (i) devalue the exchange rate, (ii) import foreign workers to alleviate labor market tightness and (iii) increase labor productivity. The first can have damaging unintended consequences in an open economy. Too large an influx of foreign workers can lead to resentment by the host population and may impose other costs. Thus the viable labor market strategy is one that combines judicious measures to augment the labor force with those that upgrade skills to increase productivity. 3. The beneficial efficiency and equity effects of upgrading labor skills can be seen in a simple growth accounting exercise. In 1988-93, labor income in Malaysia constituted 60 percent of GDP and labor contributed nearly a quarter of average real GDP growth of 8.7 percent. With capital contributing 63 percent of GDP growth, the residual is total factor productivity growth of 10.4 percent or 0.9 percentage points of real GDP growth, which is lower than Thailand's 2.5 percent and Korea's 3.5 percent. An important determinant of TFP growth is workers' skills. Investment in skill upgrading thus increases total factor productivity growth as. well as labor's income share, and will help sustain Malaysia's long term growth. 4. A comprehensive strategy to upgrade the labor force would have four prongs: (i) improving secondary and higher education to raise the general technical competency of the work force and increasing the "trainability" of workers, (ii) controlling the escalation of non-wage costs of labor and incorporating wage flexibility to reward workers and firms for productivity improvements, (iii) augmenting the labor force by tapping more female labor, facilitating workers' move from agriculture to manufacturing and developing a transparent and consistent immigration policy and (iv) strengthening institutions and policies to encourage firms to invest in worker training programs. This report elaborates the last three prongs of the labor market strategy. - ii - 5. The first prong, which involves laying a solid education foundation, is critical in raising entry-level quality of the labor and subsequent skill upgrading. This requires strengthening mathematics and technical content of the curricula at the secondary level to improve the quality of those who enter the labor force after secondary education and also to improve the tertiary level intake. At the university level, Malaysia will need to build on its excellent record at lower levels of education to increase both enrollments as well as the quality of those who graduate. As discussed in a previous report (Malaysia: Fiscal Reform for Stable Growth - 10120 MA, April 1992), this will require greater private sector involvement in tertiary education to lighten the burden on public exchequer. Reform of public universities is also needed to improve teacher recruitment. Student fees that reflect the cost of higher education will not only facilitate public provision of higher education but will also make for a more responsible student body. These and related issues are taken up in detail in a forthcoming Government-Bank sector report. A. Labor Market Trends and Emerging Skills Shortages 6. The turnaround in Malaysia's labor market is evidenced by the fact that between 1987-93, the economy generated 1.4 million jobs. The average annual employment growth of 3.9 percent in this period was much higher than the domestic labor force growth of 3.1 percent. The employment gap of 0.8 percent has made immigration unavoidable, particularly since the unemployment rate is below 2.8 percent. Indeed without immigrant workers, labor market tightness in Malaysia and the consequent pressure on wages would be even greater. 7. Most of the new jobs were created in the manufacturing sector. The share of manufacturing labor force increased 8.5 percentage points to a quarter of the labor force as this sector became the largest employer of workers. The rapid increase in demand for manufacturing labor resulted in a 55 percent hike in the average real wage. And since wages constitute as much as 38 percent of total costs (in textiles for example), this has fueled concern for the firms' costs and profitability. Moreover, the emerging skills shortage has resulted in widespread labor pinching and complaints of reduced productivity associated with increased labor turnover. The evidence of increasing unit labor costs in sectors such as food processing, electric machinery manufacture and manufacture of rubber products supports this. 8. A disturbing trend in Malaysia's labor market is that the skill composition of the manufacturing labor force is deteriorating. One measure of skill intensity of the work force, the ratio of skilled to total workers, has fallen from 0.43 in 1985 to 0.347 in 1991 with a sharp decline registered in electric machinery manufactures, fabricated metal products and rubber products. In part, this might reflect problems of defining relative skills when all jobs have become more skill intensive, but to the extent that it captures loss of skill intensity over time, this trend needs to be reversed. 9. As labor demand has increased, skilled workers have started to enjoy a wage premium. In most manufacturing sub-sectors in 1987-91, wages of skilled workers grew much more rapidly than those of unskilled workers. Moreover, when - iii - wages have fallen, they have done so more rapidly for the relatively unskilled workers. If this inequality in wage growth is a signal for the economy to supply more skilled workers and the economy responds in due course, then the signal will have served a useful purpose and the inequality in income growth is transitional. However, if there are serious supply bottlenecks that prevent an adequate supply response, this pattern of wage growth has unsatisfactory consequences for income distribution as well as for investment. 10. The formal analysis presented in this report shows that the labor market is indeed supply constrained; the current pattern of wage growth is worsening interpersonal income inequality and is tarnishing Malaysia's excellent record on reducing income inequality. This conclusion is based on the findings that, (i) there has been less investment in skill intensive industries and the investment that has taken place has had a greater effect on unskilled than skilled labor demand; therefore, skilled wages have not been pushed up by the pattern of investment; (ii) the demand for skilled workers is less elastic than that for unskilled workers but this explains only a small gap in skilled and unskilled worker wage and (iii) the most important determinant of the wage gap is the much smaller supply elasticity of skilled workers. 11. The other undesirable consequence of supply constrained wage growth is that it discourages foreign direct investment as well as domestically financed investment in the very industries that Malaysia needs to encourage in order to transform itself into an industrial economy. The evidence on changing perceptions comes from surveys of foreign investors in South East Asia that show that potential investors increasingly voice concern about Malaysia's tightening labor market. The surveys reveal that wages for engineers and managers in Malaysia are the highest in the region as is the wage gap between skilled and unskilled workers. Those questioned also report considerable recruiting and training difficulties of skilled workers in Malaysia. These perceptions quickly affect investment; between 1992-93 foreign investment approvals given to Japanese and Taiwanese investors fell sharply over previous years. B. Containing Non-waae Costs And Institutina Waae Flexibility 12. Labor costs faced by firms consist not only of the wage component as discussed above but also non-wage labor expenses such as payroll taxes and fringe benefits. In a tight labor market, nonwage costs tend to increase and put additional pressure on unit labor costs. Nonwage payments, when they are non- mandated incentive payments, also impart flexibility to wages and constitute an important incentive for workers to increase productivity. Thus firms closely monitor trends in nonwage costs to evaluate unit labor costs and competitiveness. 13. In Malaysia, although the estimated ratio of non-wage costs to the total wage bill is half that of OECD countries, the trend is on the rise. The ratio of nonwage costs to wages in Malaysian manufacturing was below 15 percent up to 1990, but with the 1 percent increase in Employees Provident Fund (EPF) contributions and the 1 percent levy for the Human Resource Development Fund (HRDF), measured nonwage costs in manufacturing are likely to be more than 20 percent today. The intersectoral variations in the ratio of nonwage to wage costs are also disconcerting. While the ratio varied between 15 and 20 percent - iv - in manufacturing between 1985 and 1991, the plantation sector had a ratio exceeding 45 percent. The experience of OECD countries is that countries with relatively higher non-wage costs have created fewer jobs. The intersectoral variation in job creation in Malaysia is remarkably similar. 14. Three sets of issues arise in containing non-wage expense: Emplover EPF Contributions and Other Payroll Levies. 15. First, it seems that the multiple definitions of payroll, depending upon the levy, cause much confusion and needs to be simplified. For example, the definition of payroll for the EPF includes bonuses, while that for the HRDF does not. The treatment of wages for foreign workers is also different across these contributory schemes. There are four definitions of wages in the Employment Act alone. This report recommends that a single definition of "wages" be used to compute employer dues for EPF, SOCSO, HRDF and any other levies. 16. Second, it appears that the burden of these levies has increased substantially over time, while the levy base has increased simultaneously, squeezing employers from two sides. Employers seem to have accepted these rates, but there are gaps in coverage (some sectors and some firms are still not covered). Moreover, the rates of compliance differ across sectors, causing distortions. Also, preliminary estimates based on EPF data between 1951 and 1993 indicate that the best schemes for raising EPF contributions entail raising employee and employer coverage or employee contribution rates, rather than employer contribution rates. Means to increase coverage of EPF and other levies need to be explored, with the auxiliary aim of reducing intersectoral differences. This may involve spinning off some of the EPF investment functions to other agencies, and having the EPF concentrate on coverage. 17. Third, payroll levies, by excluding foreign workers, raise the incentives for employing foreign labor. While foreigners can opt to contribute to the EPF, most do not. And the foreign labor tax may not level the playing field. The report suggests that employer contributions to EPF, HRDF, and SOCSO be made mandatory for foreign workers. The money collected can be used to train Malaysians and to strengthen immigration department capacity. Implementing this would require making labor agents or contractors liable for payroll taxes. FrinQe benefits 18. This report finds that fringe benefits vary across sectors, and that there are probably very good reasons for this. For example, nonwage costs are about 20 percent of wages in manufacturing, but more than 40 percent in the plantation sector due to mandated housing and medical benefits. Recent changes in the workforce however, appears to have made this a problem. The plantation sector seems to be moving from reliance on family labor to single -- often foreign -- workers, who may value money wages relatively more. But mandated nonwage costs imply that the plantation sector cannot pay high cash wages, and so may be disadvantaged relative to other sectors. These changes warrant the repeal of laws mandating housing and other fringe benefits for the plantation sector. v 19. Second, the maternity benefits required by law are quite generous. While the desirability of these benefits cannot be determined by economic considerations alone, their existence makes it difficult to determine whether higher labor force participation by women is constrained by the higher costs of employing women relative to men, or whether the constraints lie elsewhere, The rapid decreases in fertility rates during the last decade are likely to have diminished the desirability of generous mandated maternity leave and benefits. These nonwage mandates may, however, lead employers to view women as relatively more costly to employ, leading to a downward "adjustment" in the wage component of compensation. Banuses. Overtime, and Other Rewards 20. A 1993 survey of 900 enterprises in Malaysia documents that 50 percent of the firms pay contractual bonuses to their workers while about 60 percent pay incentive-based bonuses. Paid at the end of the year, bonuses are an important vehicle for profit sharing: on average, they constitute between 1.5 to 2 months of the annual wage across different categories of workers. The analysis shows that incentive-bonuses reduce labor turn-over and thus contribute to increasing productivity. Moreover, incentive-based bonuses are less frequently observed among firms that have strong industry-wide labor unions, which supports the generally held view that such bonuses work best in the presence of in-house labor unions. 21. The report's first recommendation regarding incentive-based payments is that an in-depth review be held of the role of collective bargaining in determining the non-wage component of the wage packet. In particular, the role of unions in negotiating bonuses and "merit increments" needs to be examined. Japan's experience indicates that a truly flexible wage system in the presence of collective agreements can be instituted with in-house workers' unions. 22. The second recommendation is to-design and implement appropriate legislation and economic incentives to strengthen in-house worker unions, that are likely to be more supportive of tying wages to performance and in promoting worker training. In the meantime, additional legislation that will rob the system of wage-flexibility due to bonuses, overtime work provisions, and other non-wage incentives should be avoided. C. Auamentinf the Domestic Labor Force 23. To relieve labor shortages and the pressure on wages, three potential sources for augmenting the labor force in Malaysia are, (i) increasing the participation of women in the labor force, (ii) facilitating the shift of labor out of agriculture to manufacturing and (iii) importing foreign workers. - vi - Increasina Female Labor Particioation 24. The labor force participation rate for women in Malaysia has increased unremarkably from 46.6 percent in 1970 to 49.9 percent in 1990. However, women have moved from low skilled, lower paid self-employment to more skilled, better paid wage employment. Moreover, women's wages are slowly catching up with the men's in most skill categories of wage employment. Thus, gender income inequality in Malaysia fell on two counts: first, women moved to wage employment; and second, the gender wage gap declined. The decline in gender inequality had a salutary effect on ethnic inequality as well. This is because the principal beneficiaries of increased female employment opportunities were Bumiputra women. This, in turn, increased Bumiputra family income and thus helped narrow the income gap across ethnic groups. 25. Despite progress, however, the gender wage gap remains quite large; on average, men's wages are nearly twice as high as women's. Moreover, in the professional worker category, wage inequality has actually worsened in recent years. This evidence suggests that there is still some catching up to be done in Malaysia to further reduce the gender wage gap. Women can be expected to increase their share of relatively more skilled employment, as their wages rise to match those of their male counterparts. 26. The potential for greater female labor in Malaysia is substantial and can be seen in the fact the Malaysia's overall (urban and rural) FLPR at 49.9% is considerably lower than Thailand's 76.3%. That female labor in Malaysia can increase under the right policy setting is clearly evidenced by female labor force participation rates in urban areas in the period 1970-87. Policies that improved mother and child health care, increased female years of schooling and increased employment opportunities in the dynamic, high wage, sectors of the economy had a salutary effect on fertility and female labor force participation. The total fertility rate declined sharply from 6.3 in 1965 to 3.7 by the end of the 1980's. The decline in fertility, because of postponement of marriage and child bearing as well as longer intervals between children, reduced the time females were out of the labor force. As a result, for the median child bearing age of 20, the urban FLPR jumped from 44 percent in 1970 to 65 percent in 1987. In fact, smaller family size and improvements in maternal and child health meant that labor force participation increased throughout the working life of female workers. 27. Female labor force participation will increase as (i) better health care induced demographic changes spread to rural areas, (ii) greater opportunities are provided for women to improve skills and a further narrowing of the gender wage differential comes about, and (iii) fringe benefits such as maternity leave are rationalized to keep female workers competitive. Sectoral Restructuring of Labor 28. Manufacturing growth has accompanied a restructuring of Malaysia's labor force, as workers have moved from low productivity, low wage agricultural jobs to high wage, high productivity manufacturing employment. Consequently, - vii - over the 1980's, agriculture reduced its share from more than one-third to about one quarter of total employment. This "release" of labor from agriculture to augment the manufacturing labor force will continue throughout the 1990's. Thus, aided by government's education policies during the NEP period, the labor market is adjusting well to the economy's needs. This source of labor will eventually dry up as rural labor scarcity and productivity improving technological innovations in agriculture bid up rural wages. However, policies that retard this process must be avoided. Thus, rural employment and crop support programs, as well as land clearing schemes must be undertaken only if aggregate productivity gains are greater than those obtained from the ongoing shift of labor to manufacturing. Towards a Rational Immigration Policy 29. The need for immigrant workers arises from the gap between the rate at which the Malaysian economy is creating jobs and the rate of labor force growth. Rough estimates show that there are about 1.2 million immigrant workers in Malaysia, or almost 1 in 6 workers. The largest concentration is in construction (70 percent of the total workforce), agriculture (30 percent) and non-government services (10 percent) . Only 3 percent of the manufacturing workforce consists of immigrants but demand in this sector is rising the fastest. A preliminary exercise reveals that migrant worker output may be as high as 12 pe'rcent of Malaysia's GDP, and almost two-thirds of migrant earnings are spent in Malaysia. 30. The extreme views on immigration in Malaysia, calling for a total ban or a completely open door policy, are unrealistic. There is little doubt that a total ban on immigration would, in the short run, further tighten the labor market and would increase the cost of labor. The largest impact will be on the plantations sector and in selected services where migrant workers are currently concentrated. The manufacturing sector will also be affected because rural wages will be pushed up which will delay the release of Malaysian workers from agriculture. Clearly, a total ban on immigration is not desirable. But neither is the other extreme of an open door policy. Malaysians are considerably richer and Malaysia's GDP growth rate is considerably higher than that of many of its neighbors. An open door policy would lead to a very large number of immigrant workers and may be socially unacceptable to the host population. A rational immigration policy would fall somewhere between these two extremes and would need to consider the following: 31. The "stop-go" policy on foreign workers in recent years has resulted in much confusion among employers and may have contributed to the growth in illegal immigration, thus having consequences opposite of those intended by the authorities. For transparency, the horizon for continued immigration should be spelled out. The horizon will depend on how quickly Malaysia makes the transition to a high value added, high technology economy which, in turn, depends on the pace at which the labor force upgrades its skills. The pace of skills upgrading will also determine the skill mix of foreign workers needed by the economy. These linkages must be explicitly recognized in announcing the policy horizon. - viii - 32. Even as the rest of the economy upgrades its skills, some sectors such as plantation aariculture and construction in particular, will continue to rely on immigrant workers to survive. As employment opportunities open up elsewhere in the ecQnomy, it is becoming difficult to retain Malaysian workers on plantations where wages are low and living conditions harsh. In the construction sector, costs would rise exponentially if Indonesian workers were to be withdrawn. In these sectors, demand for foreign workers should be met through legal contracts that are renewed periodically. The advantage of contract labor is that it allows employers to adjust employment of foreign workers to the business cycle. 33. Economic incentives need to be designed to send a signal to employers that foreign workers are additional and not cheaper labor. To that end, a fee on foreign workers should be levied equivalent to the EPF contributions of domestic labor. Such a levy would have several advantages. It would level the playing field between foreign and domestic workers and would generate savings for foreign workers which they could take with them at the expiry of their contracts. Revenues from employers' share of the levy should be used to strengthen the immigration department to reduce the time it takes to process foreign worker applications. This would help curb illegal immigration. To reduce collection costs, the administrative structures of the EPF could be used to collect the levy. The levy system would also yield a solid data base on the number of migrant workers and their occupation status. The lack of reliable data is a cause of much confusion in the current debate on immigration in Malaysia. 34. Experience in Western Europe suggests that a reaional anoroach to trade and investment can lower intrao.reaional movement of migrant workers. Malaysia has been a leader in promoting East Asian economic integration via AFTA. AFTA has no migration provisions, yet it will undoubtedly have effects on the migration flows underway in the region. Malaysia might wish to take the lead in considering how freer trade might affect migration into the country, since it is a major destination for migrant workers from AFTA countries. Illegal immigration to Sabah and Sarawak (not addressed in this report) would require effective policing but also dialogue at such regional forums. D. Strenothenina the Skills Training Proaram 35. While immigrant workers and increased participation of women in the labor force will help overcome labor shortages in the short run, the long term sustainability of growth requires upgrading the labor force. A national skill upgrading program should be anchored in a sound education system particularly, at the tertiary level. Top quality higher education, where students pay fees that reflect costs, would also make the individual the focus of skill upgrading rather than the firm. Individuals will invest in their skills and then move to jobs that yield the highest pay-off to investment in human capital. Public provision of trainino 36. At present in Malaysia, the government is the principal supplier of entry level training. In 1991-93, local public educational and training institutions provided entry-level industrial skills to 920 trainees. The cost- - ix - effectiveness of public training is difficult to gauge because unit cost data are not maintained systematically. However, trade tests suggest improvements in the pass rate from 53.2 percent in 1987 to 61.4 percent in 1993 with little difference between public and private institutions. 37. The analysis of public training providers suggests a considerable variation in performance of different training institutions as measured by the entry level labor market experiences of their trainees. In such evaluations, it is important to properly account for equity objectives to arrive at a correct ranking of training providers. For example, job placement success of a training institute located away from main industrial centers is likely to be low but then its performance should be judged in view of the equity objective it is expected to address. Allowing for such objectives, this report finds that the three principal public training institutions (ILP, IKM, and IKBN) do quite well as compared to SMVs (Secondary Vocational Schools of the Ministry of Education), though private training institutes appear to come out ahead in terms of finding employment and higher starting pay. In terms of the relevance of training to work, the public and private training institutions appear to be on par, with the SMV and IKK training being most likely to have low job relevance. The relatively low performance of SMV graduates on all outcome measures is of concern, and requires further careful study especially since vocational schools provide the single largest source of skilled technicians. 38. Given that market signals to evaluate the performance of training providers are likely to be weak, it is important to construct a reliable data base to regularly evaluate the internal and external efficiency in the Drovision of public traininQ. Data on unit training costs should be collected and analyzed on a systematic and system-wide basis. Broad based tracer surveys, such as those used in the analyses, are an important source of data on how graduates from both public and private institutions fare in the labor market, and should be conducted on a regular basis by the NVTC. These analyses should help policy makers identify potential problem areas to be resolved, develop training strategies, and improve resource allocation both among training institutions under one ministry, and across institutions under different ministries. 39. A bolder approach towards an efficient public training program, one that is consistent with the focus on the individual in accumulation of human capital, is to let public training institutions compete with private trainers to attract potential trainees. The government would issue training vouchers to workers not receiving firm based training armed with which potential trainees would shop for the best provider in the public or the private sector. The value of training vouchers should be equivalent to the total subsidy for entry level training. Such a scheme would be particularly useful during a business downturn when firms are unwilling to train workers. Tax incentives for skills development 40. The Malaysia Labor market Flexibility Survev (1988) confirmed the view that there is little skill upgrading of the workforce at the enterprise level in Malaysia; the number of workers trained is small and the quality of training - x - imparted is poor. To overcome this under-investment in training, the government embarked on a program to strengthen the demand for training through the incentive scheme DDIT in the late 1980's and the HRDF in the early 1990's. A review of these schemes suggests the following: 41. The DDIT is not very successful in upgrading worker skills: the cumulative (1988-93) number of workers trained through MIDA approved DDIT programs was only 3,253; sectoral coverage of the scheme is uneven with the electric and electronics sector accounting for 52 percent of the workers trained in MIDA approved programs; the scheme has been used principally by multinational firms; and finally, between 1988 -1993, only 9 small firms (less than 50 employees) took advantage of the DDIT. In part, this poor showing is due to costly paperwork needed to get approval but there are problems also with the design of the scheme. 42. A number of suggestions have been made in the past to streamline the design of DDIT, such as reduced paperwork and a less cumbersome procedure for approvals. Another idea is that DDIT should focus only on small firms while HRDF (discussed below) picks up the rest. However, given past trends, it is unlikely that MIDA will get more than a handful of DDIT applications each year from small firms. Unless small firms make extensive use of approved training providers, and it is unclear that they do, it must be concluded that the DDIT incentive scheme is an ineffective policy instrument for this group of companies. 43. This report supports the view that DDIT has outlived its usefulness and should now be completely replaced by the HRDF. Small firms should be brought under the HRDF and registered; however, the issue of payroll contributions for these firms needs to be resolved. The government might consider a waiver of the payroll levy for small firms, and a block grant to the HRDF from general revenues to cover the costs of their use of training services. Bringing all firms under the HRDF would eliminate duplication by two agencies, and simplify administration since the inevitable growth and shrinkage of firms above or below the 50 employee cutoff would be accommodated by universal coverage of all manufacturing firms. The HRDF Scheme 44. The Human Resource Development Fund (HRDF) was set up in 1993 to encourage greater part4.cipation by the private sector in improving the country's training needs. It is too early to judge the efficacy of HRDF in promoting training and skill upgrading. Additional years of accumulated information and experience with the different schemes will be needed to do that. In the short- term, several measures may be undertaken to improve the effectiveness of the HRDC Secretariat and the administration of the HRDF. 45. The reimbursement rate should be simplified. Its range has recently been revised from 50 to 80 percent and has been designed to give employers greater incentives to train in critical skills and in smaller companies. However, the differential in rates is still large and is unlikely to have much influence on training mix; employers will train wherever their skill needs dictate. One single reimbursement rate, at 80 percent of the expenses, would allow companies to make training choices and skills mix appropriate to their - xi - specific circumstances; to the extent that the reimbursement is partial, they have an incentive not to spend on frivolous' training. A single rate would also simplify the application process for both employers and the HRDC, and eliminate uncertainty on the part of firms about reimbursement rates. 46. It is recommended that the HRDF be corDoratized, and given greater autonomy over personnel and policy matters. The Secretariat should move quickly to fill higher level professional positions, and establish a training development unit to develop and promote new and innovative training programs in close cooperation with the private sector. 47. The apolication and aooroval procedure should be streamlined wherever feasible. Recognizing that government has legitimate administrative data needs, the approval procedures could be streamlined in two areas. First, the Human Resource Development Council (HRDC) could focus on certifying providers under the PROLUS scheme, rather than the current procedure of approving specific ATP courses. The operation of the market (employers and providers) would determine what training courses are demanded and who should supply them. However, a mechanism should be instituted for eliciting complaints and for periodic review of training providers. A second area is to grant exemptions from the payroll levy for companies with a demonstrated track record of extensive employee training, which would reduce administrative costs for these companies and for the HRDC. However, there should still be reporting requirements and periodic review of companies records to monitor compliance. 48. An arrangement in which the HRDF uses certified trainina Droviders as aacents' should be given serious consideration. This proposal has tangible benefits for all parties. In essence, training providers would charge trainees the portion of costs that is reimbursable (say 30 percent), and submit a request to the HRDF for the balance of costs (70 percent). This arrangement should appeal to both employers (no paperwork and low upfront costs) and training providers (scale economies in billing the HRDF and a marketing tool for attracting trainees) . It also has several administrative benefits for the HRDC, reducing paperwork and simplifying oversight of the ATP scheme. 49. To conclude, Malaysia's successful transition to an industrialized society crucially depends on how well the labor needs are met. More workers as well as more skills will be needed to maintain the growth momentum. In the public sector, better trained civil servants will be needed to regulate the activities of the much enlarged private sector. The government is gearing up to meet this challenge by reforming the formal education system, particularly at the higher level. Those reforms and the recommendations made in this report on containing non-wage costs, managing the flow of foreign workers and skill upgrading, will go a long way towards producing a labor force that quickly adapts to new technologies to meet the challenges of Malaysia's next growth phase. I. MALAYSIA'8 GIGHT LABOR NARKIT Introduction 1.1 Malaysia's labor market has experienced a sharp turnaround following the recession of 1985-86. Between 1987 and 1993, the economy generated 1.4 million additional jobs, mostly in the better paying industrial sector. Consequently, the structure of the labor market changed: the share of agriculture in total jobs declined 9.4 percentage points to 21.4 percent and that of manufacturing increased 8.5 percentage points to 24 percent (see Table 1.1). Furthermore, the importance of government employment also decreased. As a result of this rapid growth in private sector jobs, government's policy stance has shifted from the perennial concern for creating employment opportunities to absorb the unemployed to one where skills upgrading for productivity growth has come to occupy center stage. 1.2 Upgrading the labor force will be essential to sustain the growth momentum in the long term. This is because labor income constitutes nearly 60 percent of GDP and labor contributes nearly a quarter of GDP growth. This can be seen from a simple growth accounting exercise in Table 1.2. Between 1989 and 1993, public and private fixed assets in Malaysia increased by an average 13.7 percent per annum in real terms. Assuming capital's share in GDP at 0.4. capital's contribution to GDP growth is calculated at 63.2 percent. Meanwhile, the average rate of labor force growth in this period was 3.9 percent, which gives its contribution to GDP growth at 26.4 percent (Table 1.2). The residual GDP growth of 10.4 percent is the total factor productivity growth (TFP), which captures the quality or the skills component of the labor force. In the years to come TFP growth will need to be increased to sustain the growth momentum that Malaysia currently enjoys. This, in turn, will require investment in skills and in the education system to improve the quality of labor. 1.3 This report analyzes the main trends in Malaysia's labor market and recommends policy changes for upgrading the labor force. The remaining discussion in this chapter reviews the wage trends and the skills composition of the labor force and argues that skills shortages arise principally due to supply bottlenecks. The potential for increasing the supply of female labor is also explored. Chapter II examines the non-wage components of the wage package to comment on whether these constitute additional burden on firms and workers. A more rational structure is recommended and the role of bonus payments in wage- flexibility is explored. Chapter III examines Malaysia's immigration policies to comment on whether these are consistent with the country's objective of enhancing labor skills. Finally, Chapter IV reviews Malaysia's policies for skills development in the light of international experience. Talble 1.1: Employntwn( ly Seetljr, IY87-19Y3 Total Agriculture, Mining and Manufaiuring Conouruction Finance, Tran.sport, Storage and Go(vernment Other Services Forestry and Quarrying Insurance, Cotmmunication Services Fishing Business Services and Real Ebtale (uinits '(X)t)) 1987 5,984 1,846 33 929 336 242 252 836 1,510 1988 6,176 1,889 29 987 340 230 266 845 1,590 1989 6,390 1,833 33 1,171 377 253 278 847 1,598 1990 6,686 1,738 37 1,333 424 258 302 850 1,744 1991 6,926 1,680 36 I,500 465 279 314 854 1,798 1992 7,148 1,630 36 1,640 507 300 326 858 1,851 1993 7,371 1,580 35 1,766 550 315 342 862 1,920 '% slhare 1987 100 30.8 0.6 15.5 5.6 4 4.2 14 25.2 1993 100 21.4 0.5 24 7.5 4.3 4.6 11.7 26 Additional joh created bctwen 1987 and 1993: 1,387 -266 2 837 214 73 90 26 410 Source: Economic Report 1993/94, Ministry of Finance Malaysia. -3- 1.4 The recent developments in Malaysia's labor market are a testimony to the successful transition of the economy from being mainly a primary goods producer twenty years ago to a new East Asian industrial tiger. The policies to educate the labor force and facilitate access to modern sector jobs worked in tandem with measures to stabilize and liberalize the economy. The result was sustained growth over a thirty year period leading to a large urban/industrial labor force and rapid wage and income growth. The labor market issues now being faced are a product of this successful transition. Table 1.2: Simple Growth Accounting in Malaysia (1988-93) Average GDP Growth 8.7 Growth in real fLxed assets 13.7 Employment 3.9 Contribution to Growth* Percentage Contribution to GDP Grow-th Capital 5.5 63.2 Labor 2.3 26.4 Total Factor Productivity 0.9 10.4 - Assuming Cobb-Douglas production function and capital and labor shares in GDP of 0.4 and 0.6 respectively. A. Emerrina Trends in the Labor Market 1.5 The changing employment pattern and rapid job growth have both contributed to the tightening of the labor market. There are several indicators of this. The unemployment rate reported at 7.3 percent in 1987 fell to an estimated 2.8 percent in fiscal 1993i'. In 1987, 71 percent of the reported manufacturing job vacancies were filled within the year, whereas in 1993 as many as 76 percent of the vacancies went unfilled. Surveys of voluntary turnover, that reflect relative skills scarcity, continue to show high turnover for several categories of skilled and professional workers.Y This is also underscored in the frequently reported stories of "job pinching" in the press. 1.6 Labor market tightness is best captured in wage movements. according to the survey on private sector wage agreements, in the period 1987-92, the average real wage in Malaysia increased 46 percent. The increase in manufacturing real wage was even steeper; on average, it increased 55 percent in 1' Economic Report, 1993/94. Government of Malaysia. v Employment Turnover Survey, 1992. Jabatan Tenaga Rakyat. this period (Figure 1.1) . Such rapid wage increase can have serious consequences for the firm's cost structure and profitability since wages constitute between 10 percent (petroleum) and 38 percent (textiles) of total manufacturing costs. They range from 2 percent (petroleum) to 22 percent of value added (paper and paper products). Figure 1.1: Private Sector Real Wage Ind I co 160 150 _ 140- 130 x 120 110 100 1G97 1998 1969 1990 1991 1992 o manufacturln t 5.rvrcos 0 Aariculttro A Total Source: EPU. - 5 - Figure 1.2 WAGES AS SHARE OF COSTS AND VALUE ADDED 0.45 0.4- 0.35 D.M _ 0 2.2_ 0.13 a. I1 0.02 a~~~~~~~aT i 5.TGt I out a wb'v 11 MetE 1 Food beverage tobacco 2 Textile apparel footwear 3 Wood products & furniture 4 Paper & publishing 5 Chemicals petrol & rubber 6 Ceramics glass & minerals 7 Ferrous & metal products 8 Fabricated metals 9 Machinery 10 Electrical machinery 11 Transport equipment 12 Prof/scientific equipment 13 Other manufacturing 1.7 Rising wages in themselves are not worrisome if productivity growth keeps pace, since this ensures that firms' profitability is unaffected. What really matters to firms is the unit labor cost that measures the change in labor costs relative to productivity growth. Figure 1.3 shows how unit labor costs have evolved in Malaysia in recent years. In three of the five largest manufacturing sub-sectors (in terms of share of value added) i.e. food processing, electrical machinery, and manufacture of rubber products, unit labor costs have now started to rise. 1.8 Increase in unit labor cost affects firm profitability, which has a bearing on investors' perceptions regarding Malaysia's competitiveness. It is important, therefore, to check this trend early. This will require a different policy response than that of the 1980's, when exchange rate depreciation and wage restraints helped to bring down unit costs. With the economy at full employment wage restraint is harder to negotiate and with large portfolio investments, exchange rate movements can have complex outcomes. Maintaining competitiveness now requires a greater effort to upgrade the labor force to increase skills and thus increase productivity. Figure 1.3 Unit Cost of Labor of Top Five i~~~~0 ,.1- low L. . 10 ~ ~ ~~~IvmtcL X1~ I r Sar ir I Fo CWICI ,q, oUX A . .rMt X 11O,rQ,& V TM, source: Industrial Survey. The Skill Composition of the Labgr Force 1.9 The direct evidence on skill composition of Malaysia's labor force is not encouraging. Using the standard classification of the work force reported in data reported by the National Productivity Corporation, Malaysia'Is labor force is divided into managerial and professional cadre, skilled workers,F semi- skilled workers and unskilled workers. The ratio of the first two and the total work force gives a measure of skill intensity of labor. According to this measure, the aggregate manufacturing labor force became less skill intensive between 19B5 and 1991. The ratio fell from 0.43 in 1985 to 0.35 in 1991 (Figure 1.4). 1.10 The trend of declining skill intensity appears to hold across most manufacturing subsectors (Table 1.3). The fall in the ratio ranges from 17 percent in paper & paper products and 18 percent in textiles to 42 percent in the I'Malaysia's Department of Statistics defines skilled workers as those workers who have received formal training (either in-service training or other types, e.g., formal training in an institution) for their specific job. manufacture of electrical machinery, appliances and supplies. The index of skill intensity also fell in rubber products, fabricated metal products and the manufacture of transport equipment. Figure 1.4, Ski I I Intensity of AnuVateLr 1ng Wokrs 0.44 0.43- 0.42 . D \ 0.941 ,. ,. a 0.47 0 .3S " 0.35- 0.38 iis liii 1337 Ing 1ims 13o 1191 Source: Industrial Survey. 1.11 The evidence of falling skill intensity of the employed is in direct contrast to the government's declared objective of upgrading the skill composition of the labor force to move to higher value added products. This perverse outcome could be because of: (i) a demand constraint i.e. the technologies embodied in the investment in this period of rapid growth require less skilled workers or (ii) a supply constraint i.e. the formal education system and training schemes are not producing enough skilled workers or (iii) a combination of the two. The analysis presented in part B attempts to formally identify the reasons. Table 1.3: Ratio of Skillad to Total Workers* 1985 1992 Percentage Change Total 0.432 0.347 -19.8 Food Manufacturing 0.271 0.308 13.8 Manufacture of Textiles 0.616 0.504 -18.1 Paper & Paper products, printing etc 0.405 0.335 -17.3 Industrial chemicals & other chem. 0.284 0.350 23.3 Petroleum refineries & misc. prod. 0.478 0.492 2.9 Rubber & products 0.300 0.231 -23.1 Non-metallic mineral products 0.268 0.313 16.5 Iron and steel basic industries, and nonferrous metal basic industries 0.369 0.375 1.6 Fabricated metal products except 0.393 0.299 -24.0 electrical Manufacture of electrical machinery apparatus, appliances & supplies 0.635 0.367 -42.2 Manufacture of transport equipment 0.523 0.386 -26.2 * Ratio of skilled workers to total workers including skilled, semi-skilled and unskilled workers. Source: Industrial Survey, Malaysia The Pattern of Waae Growth 1.12 An analysis of the wage trends would be a useful first look to identify informally whether decline in skill intensity is demand constrained. But there is another important reason to look at the evolution of wages. Malaysia has an impressive record in reducing poverty and ethnic income inequalities.v Indeed, the sustained prosperity that the country has enjoyed has been ascribed to the political stability associated with successful poverty alleviation and reduction in income disparities. Since wage income is the largest component of personal income, there is some concern that the recent pattern of wage growth may have contributed to the problem of interpersonal income inequality. These issues are examined next. F' Analyzed in "Growth, Poverty Alleviation and Income Distribution in Malaysia: Changing Focus of Government Policy Intervention," Report No. 8667-MA. World Bank. January 1991. - 9 - 1.13 Across skill categories: Increase in skilled worker wages at a time of declining skill intensity of the labor force is a reflection of the scarcity premium that skilled workers enjoy. The evidence to determine whether this is true in Malaysia can be seen in the differences in wages across different skill categories of workers within manufacturing. 1.14 Within manufacturing, earnings differential across workers has increased. Salaries of skilled workers have grown much more rapidly than the salaries of unskilled workers (Table 1.4). This is true in most manufacturing sub-sectors. Moreover, when salaries have fallen, they have fallen more sharply for the less skilled workers. 1.15 The evidence presented in Table 1.4 suggests that the demand for skilled workers continues to be strong so that the problem of declining skill intensity of the labor force is primarily due to inadequate supply of skilled workers (more on this below). This evidence also suggests that interpersonal income inequality may have increased in the period of rapid income growth, which may have tarnished Malaysia's impressive past :ecord in reducing poverty and ethnic income inequalities. Policies that increase the supply of skilled workers would thus not only shift the economy to a higher value added production base to sustain the growth momentum but would also reduce interpersonal income inequalities arising from the premium that skilled workers currently enjoy. - 10 - Table 1.4: Percentage Cbange In Wages of Different Categories of Worker 1987-91 (at 1985 prices) Major Group Managerial- Skilled Workers Semi-Skilled UnsklUed Professional and Direct and Workers Direct Workers Direct Non Professional Contract and Contract and Contract Total 7.7 10.7 9.7 4.9 Food Manufacturing 7.3 1.4 5.4 1.6 Manufacmre of Texiles 5.3 16.4 3.1 18.9 Paper & paper products, printing etc 25.1 16.9 4.5 5.0 Industrial Chemicals & other chem. 2.8 6.6 -0.7 -2.2 Petroleum refineries & misc. prod. 3.4 0.5 1.1 16.2 Rubber & products -4.4 7.1 58.1 -14.7 Non-metallic mineral products 19.4 5.1 5.2 -8.6 Iron and steel basic industries, and 0.8 1.0 26.4 -2.1 nonferrous metal basic industries Fabricated metal products except electrical 20.6 11.0 -1.0 10.3 Manufacturer of electrical machinery apparatus, appliances & supplies -6.0 12.0 19.9 7.6 manufacture of transport equipment 34.1 8.0 10.6 23.9 Source: Industrial Survey, Malaysia 1.16 Across gender: Women have played an important role in Malaysia's recent developmenty' and female labor will continue to be an important source of growth in the future. Rapid and sustained economic growth results when a developing country catches up with industrialized countries. This involves two sorts of catching up: (i) catching up with the industrialized countries' technological frontier and (ii) the under-employed domestic factor catching up with the modern sector workers. The latter is facilitated by openness and foreign investment, that create job opportunities, and education, that makes the underemployed factor employable in the modern sector. In Malaysia, women were the under-employed factor. Armed with education through the 1970s and the 1980s, women moved from traditional self-employment to modern sector jobs created by foreign investment and government. This vent for the under-employed factor facilitated the double catch-up and sustained Malaysia's long-term growth. 1.17 The labor force participation rate for women in Malaysia has increased unremarkably from 46.6 percent in 1970 to 49.9 percent in 1990. However, women l' "Female-led Growth in Malaysia" by Surjit Bhalla, Homi Kharas and Ijaz Nabi (forthcoming). - 11 - have moved from low skilled, less well-paid self-employment to more skilled, better paid wage employment. Thus, gender income inequality in Malaysia fell as women moved to wage employment. The decline in gender inequality in access to skilled jobs had a salutary effect on ethnic inequality as well. This is because the principal beneficiaries of increased female employment opportunities were Bumiputra women. This, in turn, increased Bumiputra family income and thus helped narrow the income gap across ethnic groups. 1.18 Despite the gains, however, the gender wage gap remains quite large (Fig 1.5); men's wages are on average nearly twice as high as women's. And in the professional worker category, wage inequality has actually worsened in recent years. This evidence suggests that there is still some catching up to be done in Malaysia to further reduce the gender wage gap. Women can be expected to increase their share of relatively more skilled employment, as their wages rise to match those of the male counterparts. 1.19 That female labor in Malaysia can increase under the right policy setting can be seen clearly in the evidence on female labor force participation rates in urban areas in the period 1970-87. Policies that improved mother and child health care, increased female years of schooling and increased employment opportunities in the dynamic, high wage sectors of the economy had a salutary effect on fertility and female labor force participation. The total fertility rate declined sharply from 6.3 in 1965 to 3.7 by the end of the 1980's. The decline in fertility, because of postponement of marriage and child bearing as well as longer intervals between children, reduced the time females were out of the labor force. As a result, for the median child bearing age of 20, the urban FLPR jumped from 44 percent in 1970 to 65 percent in 1987. In fact, smaller family size and improvements in maternal and child health meant that labor force participation increased throughout the working life of female workers (Fig 1.6). 1.20 The salutary policy setting needs to encompass the entire female labor force (in both rural and urban areas). This, combined with opportunities for women to improve skills and a further narrowing of the gender wage differential, will help improve the aggregate FLPR. The potential for greater female labor in Malaysia is substantial and can be seen in Table 1.5 that compares Malaysia's overall (urban and rural) FLPR (47.3k) with Thailand's (76.3%). - 12 - Figure 1.5 Trends in Gender Inequality in Earnings CF4msl. to Wfie oa Patlos 0.I 0.76 _ 0.78 0. 74 0.72 0.7 a . Be 0.80 0.62 0.0 0 .s _ 0 . so 0.54- 0.32- 0. 5 0.40 0.48 1996 19g9 1990 1991 0 AI wrlre + Pre or_ tlon lc Non-rcofeelnsleo a TCch l co l X Cle_tcal V General Note: All workers consists of the categories given here plus other part-time and full time workers. Table 1.5: Total Labor Force Partkipation Rate a/ 1970 1980 1990 Female Male Female Male Female Male Thailand 76.8% 90.0% 59.7% 76.1% 76.3% 87.7% b/ Malaysia 46.6% 81.3% 47.3% 85.5% 47.3% 79.7% b/ o/ Total mnber of people economically active as a percentage of total number in the working age population of 15 to 64 years. Sowce: Yearbook of Statistics 1974, 1984, 1988, 1993, Table I - 13 - Figure 1.6: Female Labor Force Psrtrcipstion (iebmn) 70 50- 30 20 15-19 25-29 35~-39 45-49 55-59 Age GroLip 0 1970 +4 1980 o 1987 1.21 Release of labor from acriculture and services sectors can also augment the labor force available to manufacturing, and thereby help moderate wage increases in periods of rapid expansion. 1.22 Since the late 1980's the growth of manufacturing employment has been a very rapid 9 percent per year, despite the under 3 percent growth of labor force (Table 1.6). This could coexist with moderate employment growth in non- manufacturing sectors at 3.5 percent per year because of two favorable factors. One was the availability of a very large pool of unemployed workers -- the unemployment rate of,nearly 7 percent in 1985 was still at 5 percent in 1990. The other, more significant, factor has been the sustained release of labor from agricultural employment at over 3 percent per year since the late 1980s. Seen in another way, over the period 1987-94, over 15 percent of the additional jobs created in non-agriculture were filled by the labor released from agriculture. This contribution increased to nearly 20 percent during 1990-94 because reduction in unemployment has slowed down with unemployment approaching its "natural" floor. 1.23 The services sector is a prime candidate for reducing non- manufacturing demand for labor. In accounting for 40 percent of employment it appears to have substantial room for being transformed into a leaner sector. The government services sector has been virtually stagnant in recent years. It is the rampant growth in the other services (commerce, financial services, restaurants, etc) -- at nearly 3.5 percent per year -- which needs to be channeled into more productive manufacturing employment. - 14 - 1.24 An accelerated decline in agricultural employment combined with reduced growth in the services sector has two distinct advantages. First, it will avoid the potential problems of a major increase in immigration; second, it will require a modest increase in female labor force supply. Rough estimates are that a 6 percent annual reduction in agricultural employment plus a moderately rapid labor force growth rate (3.4%) could sustain a very high manufacturing employment growth rate (9k) and moderate expansion in non-manufacturing employment (3k), and also allow for a plausible unemployment level (4%) . The required labor force growth could be achieved by a modest increase in the female participation rate (about 53% versus 47k in 1994). 1.25 An annual decline of 6 percent in the agricultural labor force would be an ambitious but feasible target. Useful comparisons can be made (table 1.7) with two relevant countries in the region -- Korea and Japan -- when these countries were in a similar stage of development as Malaysia is today. In 1980 Korea and Malaysia were similar in the share of agriculture in employment, of around 35 percent. By 1985 Korea had reduced the share to 25 percent, whereas Malaysia did not reach the same level until the end of the decade. Furthermore, between 1985 and 1990 Korea was able to reduce the share by 7 points, whereas in the same length of time Malaysia could reduce the share of agricultural employment by about half as many points. 1.26 Japan may be used as an illustration of the scope of reduction in agricultural employment. In 1970 Japan had the same level of GNP per capita as Malaysia in 1985. But Japan had by then succeeded in rapidly reducing its use of labor in agriculture to only 19 percent of the labor force, whereas agriculture in Malaysia still accounted for 30 percent of employment. Finally, consider the year 1975 when GNP per capita in Japan was at a level that Malaysia expects to attain in the near future -- around US$45000. At this income level the share of agriculture in employment in Japan had declined to 14 percent. With a current employment share of 20 percent, this target level can in fact be easily achieved by Malaysia in the year 2000 -- with total employment growth of around 3 percent per year, agriculture would need to release labor at about the same rate. - 15 - Table 1.6: Trends In Sectoral Employment, Malaysia 1970 1975 1980 1985 1990 1994 Employment Shares (%) 100 100 100 100 100 100 Agriculture 51 45 37 30 26 20 Manufacturing 11 13 IS 15 20 25 Non-Manufacturing 38 42 48 55 54 55 Services 28 31 36 42 43 42 1970-80 1980-90 1980-85 1985-90 1990-94 Annual Growth (%) Labor Force 3.4 3.2 3.4 3.0 2.8 Employment 3.6 3.3 3.2 3.4 3.3 Agriculture 0.5 -0.4 -1.0 0.2 -3.0 Manufacturing 6.9 5.9 2.6 9.4 9.1 Non-Manufacturing 5.8 4.7 6.2 3.2 3.7 Services 6.3 4.9 6.1 3.7 2.8 Source: Economic Reports; ILO Yearbook of Labor Statistics; World Tables Table 1.7: Comparative Trends In Sectoral Employment Malaysia 1975 1980 1985 1990 1994 GNP per capita (S) 820 1690 1980 2360 - Share of Agriculture in Employment 45 37 30 26 20 Index with moving base - 0.8 0.8 0.9 0.8 Korea 1975 1980 1985 1990 1992 GNP per capita (S) 580 1620 2340 5450 - Share of Agriculture in Employment 46 35 25 18 16 Index wi.h moving base - 0.8 0.7 0.7 0.9 Japan 1955 1960 1965 1970 1975 GNP per capita (S) - - - 1930 4520 Share of Agriculture in Employment 40 32 24 19 14 Index with moving base - 0.8 0.8 0.8 0.7 Source: Economic Reports; ILO Yearbook of Labor StatistiCs; World Tables - 16 - Conclusions: 1.27 The evidence on Malaysia's tightening labor market shows that skills shortages are the result of supply constraints. Inadequate supply of skills in the presence of strong demand has bid up the wages of skilled workers and has lowered the skills intensity of the labor force. This increases inter-personal income inequality and also discourages skill intensive investment. Moreover, it is in direct contrast to the government's declared objective of upgrading the work force to move to higher value added products. Improving formal education and occupational training programs will go a long way towards relaxing the constraints on the supply of skills, which is essential for Malaysia to maintain its targeted growth rate in the medium term. The potential for increasing skills in Malaysia is substantial, given the current enrolment gap in higher education with respect to its competitors. Another source for increasing the pool of skilled workers is female labor. Female labor force participation rates can be improved considerably by investing in female education and training, which will further reduce the gender wage gap and thus will encourage more women to work. Reduction in agricultural labor force and a slimmer services sector will also help augment the manufacturing labor force. B. The Wage Pattern and Investment 1.28 This section further interprets the evidence on the differential rates of growth of skilled and unskilled worker wages. It also presents an explanation as to why skilled worker wages have increased so rapidly compared to those of unskilled workers. It then evaluates the dampening impact of the rise of skilled worker wages, particularly at managerial and professional levels, on investment from domestic sources as well as in the form of foreign direct investment. 1.29 The equity implications of the differential rates of growth of skilled and unskilled workers, touched on in part A, are also important. It would be better if the gains of the past few years were distributed in a manner that equalizes incomes across social classes rather than exacerbate inequalities. Malaysia has been very successful in sharing the fruits of economic development over the past two decades. This period of rapid growth could have been one in which inequity was reduced. It is often easier to increase the incomes of lower income workers in a period of growth since there need be no reduction of the incomes of the relatively wealthy. The tax system has become no more progressive over the past few years and the opportunity to improve the income distribution is being missed. 1.30 If the changes in wage structure led to better signals to workers as to the value of higher skilled and professional jobs and if the workers (and students in secondary school) could act on these signals, then the current change in relative wages would serve a good purpose in leading to larger university and training school attendance. In this case, the current wage pattern is temporary. Students will respond to the better income opportunities of professional and technical workers, undertake the appropriate training and eventually bring the relative wages back down. At least in the case of university, however, it is not possible for them to do so (as will be discussed below) and the higher wages do - 17 - not translate into improved allocation in the form of more use of the training and education sectors. Why have skilled waaes risen so much? 1.31 There are a number of possible reasons for the more rapid increase in skilled wages relative to unskilled. Not all of them have policy implications. First, it is possible that the high level of investment in the economy itself that has increased wages for technical and managerial personnel relative to unskilled workers. It may be the case that higher investment disproportionately increases demand for such people. This may be simply a characteristic of technology. Unless technology choices have been biased by policy-induced incentives, there may be no problem which needs to be addressed by changes in policy. Social equity goals which are compromised by the differential growth of wage rates should be handled directly with the fiscal system. 1.32 Second, it may be that there are fewer substitutes for technical and managerial workers and that an increase in the demand for workers will translate into higher wages for a given supply. Again, this is a feature of technology and unless there is a distortion which artificially reduces substitution possibilities, there may be no policy implication. 1.33 Third, it is possible that the supply response of skilled workers to higher wages may be lower than that of unskilled workers. If this is the case, then an increase in demand for technical and managerial workers will not be met by an equal increase in their supply. This, too, would have the effect of driving up wages until the higher demand is restrained. Once again, this does not necessarily have policy implications unless there is a market failure or policy failure which unduly constrains labor supply response. 1.34 In order to disentangle the contribution of these three possible influences, a supply and demand system for different types of labor was estimated. The data came from the industrial surveys conducted every year in the manufacturing sector. The details of the estimation procedure and results are presented in Appendix 1A. The formal analysis is quite clear on the relative importance of the alternative explanations. 1.35 First, it is n the level or pattern of investment that has been pushing up skilled wages. According to the estimates of labor demand, a given increase in fixed assets increases the demand for unskilled workers more than for skilled in the manufacturing sector. As for the subsectoral pattern of investment: as suggested above, the higher wages for skilled workers has depressed investment in skill intensive industries. Therefore, there has been less investment in skill intensive industries and the investment that has taken place has had greater effect on unskilled than skilled labor demands. 1.36 Second, there is some evidence that the demand for skilled workers is less elastic (responds less to higher wages) than that for unskilled. Therefore, some of the gap can be explained this way but the amount so explained is low, as discussed below. - 18 - 1.37 Third, the most important determinant of the difference in wage rate growth is the smaller supply elasticity of skilled workers. In fact, desegregated estimates indicate that managerial and technical workers have the lowest supply response, followed in order by skilled, semi-skilled and unskilled workers. [It is hard to distinguish the supply elasticity of managerial and technical workers from zero or that of unskilled workers from a regime of fixed wages (an elasticity of 24)]. 1.38 While both supply and demand elasticities are lower for skilled workers, most of the difference in wage growth is attributable to the difference in supply elasticities. It is important to identify possible distortions which might account for the difference in supply response. 1.39 Both the statistical analysis and the basic facts surrounding the labor market argue for the supply response story as the best explanation of wage behavior. As noted in part A, the ratio of skilled to unskilled workers has been falling in most subsectors in manufacturing and in the economy as a whole. This has happened at the same time that the wages of skilled workers have been rising. This pattern is consistent with a lower supply response to increased wages in the skilled sector as established in the statistical analysis, and difficult to reconcile with a demand determined explanation. The rise in skilled wages dampens investment 1.40 The rise in wages in high skill workers discourages both foreign direct investment (FDI) as well as domestically financed investments in the very industries that Malaysia needs to transform itself into an industrial economy. 1.41 The evidence for this comes from two kinds of sources. On FDI, a recent survey was conducted examining the decisions of Japanese investors in several East Asian countries. The survey examined a variety of factors which might influence investment. For Malaysia, a consistent theme in the results is the importance of labor costs and recruitment difficulty, particularly for high skilled labor. 1.42 Tables 1.8 and 1.9 from two separate surveys show that the issue of labor cost is an important impediment to future investments to Malaysia. Tables 1.10 and 1.11 show comparative data for other countries in the region on the cost of workers of different skill categories and on the ease of recruiting and retaining skilled labor. Table 1.10 indicates that the wages for engineers in Malaysia is the highest in the region and those of managers nearly so. Also, the gap between managers and engineers on the one hand and workers on the other are highest (or nearly so) in Malaysia. On ease of recruiting and retaining skilled workers, the difficulty reported was near the highest for Malaysia (4.9 versus 5.0 as the maximum difficulty reported on a scale of 1 to 7) and the turnover rate for supervisors and technicians was second highest in the region (it should be noted that Thailand has very much the same sort of problems as Malaysia). - 19 - Table 1.8: Determinants of Future Japanese Investment In East Asia's Manufacturing Sector All Countries Malaysia and Indonesia and China and Viet Yhailand Philippines Nam Domestic market + + + + + + + + Labor cost + + + + + Parts and equipment + + FDI policy + + + + Political risk ++ + Note: + + means very significant (at 5 percent). + or - means significant (at 10 percent). Sec details in Appendix 2. Source: World Bank staff estimates based on regression analysis using the World Bank survey, 1993. Table 1.9: Operational Impediments by Japanese Afiliates in East Asia Impediments Total Malaysia Thailand Indonesia Philippines China (708) (186) (246) (103) (70) (103) Labor supply XXX XXX XXX X X XX Infrastructure XXX X XXX XX XXX XXX Subcontract XX X XX XX X XX Infation X X X XX XX XXX Ownership restriction X X X XX X Local employment restriction X XXX X Distribution system X X X XXX Local finance X X X Export requirement X Conflict with partners X Political risk XXX X Note: ()shows total number of responding affiliates in the country. XXX indicates more than 50 percent, XX indicates between 35 pereent and 50 percent, and X does between 20 percent and 35 percent, of responding companies that cited each item as an impediments to their business operation. Companies often cited more than one impediment per country. See details in Appendix 4. Source: MITI survey, 1993. - 20 - Table 1.10: Labor Costs and Increases, 1992 (US dollas) Malaysia Thailand Indonesia Philippines China iet Nam Wages/month Worker 137- 138- 25- 118- 45- 20- Manager 1178- 1181- 197- 392- N.A. N.A. Engineer 589- 394- 148- 235- 129- N.A. Rate of increase in nominal wages (percent) 9.0 15.0 20.0 11.3 (91) 14.4 NA. Source: MMII 1993, "Prospects and Challenges for the Upgrading of Industries in the ASEAN Region." Table 1.11: Ease of Recruiting Skilled Labor (On a scale of 1. very easy, to 7, very difficult) Country Dificulty of recruiting local Percent of supervisors and techniadaw supervisor and technicians who leave venture each year Malaysia 4.9 11.4 lhiland 5.0 15.2 Indonesia 4.4 7.5 Philipines 5.0 9.2 China 4.1 7.6 Viet Nam 4.3 2.5 Note: Respondents were asked how easy it is to recruit local supervisors and technicians. The sample in Viet Nam was very small. Source: World Bank survey 1993. 1.43 The combined effect of having high costs for skilled labor and reported sensitivity to this factor among investors is a potentially serious obstacle to further investment prospects. To see that this may already be influencing investment flows, Tables 1.10 and 1.11 show the change in approved investments from Taiwan and Japan in ASEAN countries from 1992 to 1993. From both sources, the investments to Malaysia show the biggest decline. 1.44 The second kind of evidence that high wages in high skill jobs discourages investment comes from domestic sources. From data provided by the industrial survey on wages in different skill categories and on investment in fixed assets, it is possible to directly measure the impact of the former on the latter. Table 1A.3 in the appendix shows the results of a regression analysis examining this impact. The effect of managerial and technical wages on domestic - 21 - investment is significant and negative. It is estimated that a 10t rise in skilled wages can reduce manufacturing investment by 4.71. While this may not seem like a large number, the cumulative impact of this difference in investment rates on the size of the capital stock can be very large. Several alternative specifications confirm the direction of this effect, even though the actual magnitudes are not very robust (that is, alternative specifications can alter the significance of this relationship). 1.45 For Malaysia to attain its "Vision 2020", it is the high skill, high tech, high quality of life investments that are essential for growth. These are precisely the type which are most discouraged by the disproportionately rising wages of highly skilled workers. Table 1.12: Japan's FDI In East Asia (Millions of US dollars) FY87-89 FY90-92 FY93 (4-12)' East Asia 7,740 11,523 2,707 (-6) China 1,961 1,998 1.157 (+47) Indonesia 1,762 3,981 600 (-33) Malaysia 1,224 2,308 314 (-45) Philippines 409 619 128 (-11) Thailand 2,384 2,621 490 (+12) Viet Nam - - 18 (+7718) Note: Notification basis. ' ( ) shows the change from the same period of last year. Source: Ministry of Finance - 22 - Tabk 1.13: Taiwan (Chna)'s FDI in East Asia, 198&93 (Milions in US dollars) 1986-89 1990-92 1993 (1-10)' East Asia 344 1,910 China - 420 2,831b Indonuia 3 262 19 (-42) Malysia 167 783 62 (-58) PhEippines 105 126 5 (+438) Thailand 69 319 54 (-35) Viet Nam - - 156 (+1534) Note: Approval basis. '()shows the change from the same period of last year. b In Marh 1993, the Government of Taiwan (China) revised regulations regarding the accuate reporing of PDI in China. Source: Investment Commission, Ministry of Economic Affairs. Why is the suoplv and waae resoonse of skilled labor so low relative to unskilled? 1.46 Two factors are likely responsible for the differential ability of skilled and unskilled labor to respond to increased wages. On the lower end of the wage ladder, the availability of low skilled immigrant labor from Indonesia and other poorer countries in Asia allows employment to increase substantially without inducing upward pressure on wages. This issue is dealt with in chapter 3. On the higher end of the wage ladder, the most plausible explanation is the very small number of university graduates, a result of higher education policy. 1.47 For a country at Malaysia's level of income, the proportion of the population attending university is very low. It is also low in comparison to other rapidly growing economies in the region. Table 1.14 shows the proportion of the relevant age group attending university in selected countries in Asia. The figure for Malaysia includes an estimate of students studying abroad (a very large number compared to other countries). The large number studying abroad reflects widespread use of a very expensive alternative to local education. 1.48 The impediment to developing a larger pool of technical and managerial level personnel is the tight limit on higher education. With no private sector allowed to grant degrees, the supply of highly trained workers must come from the restricted number of slots in the state-run university or from the recently established "twinning" program of cooperative arrangements with foreign universities. The Ministry of Education budget is not likely to grow anywhere near enough to generate the current and future needs of the economy for graduates. The twinning program, while helpful, still requires, in general, two - 23 - years abroad and increases the costs of higher education substantially relative to what could be met domestically. Table 1.14: Gross Enrolment Rados (%) by Level of Educaion, Asi 1970-1985 Country Primary Secondary Higher 1970 1985 1970 1985 1970 1985 (4) Bangladesh 54 60 - 18 - 5.2 Bhutan 6 25 1 4 - 0.1 Burma 83 107 21 23 2.1 5.4 China 89 118 24 39 0.6 1.7 India 73 92 26 41 8.6 9 Indonesia 80 118 16 42 2.4 6.5 Korea (1) 103 96 42 75 10.3 31.6 Laos 53 94 3 19 - 1.5 Malaysia 87 99 34 53 2.3 6 (8.6) Nepal (2) 22 82 10 25 2.3 4.6 Papua New Guinea 52 70 3 13 2.5 2 Philippines 108 106 46 65 18.4 33 Singapore 105 115 46 71 9 11.3 Sri Lanka 99 103 47 63 1.3 4.6 (3-1) Thailand 83 97 17 30 3.4 19.6 Average (3) 76 94 26 42 4.9 10.1 Source: Mingat and Tan, Educational Development in Asia: A Cooperative Study Pocusing on: (1) The data for a secondary school education in 1985 is lower than that reported in UNESCO (1987) since it is the average over both subcycles of secondary education. The UNESCO data refer only to the first subeycle. (2) The statistics for primary education for 1985 may be overestimated due to inaccuracies in official estimates of the relevant school-age population; (3) Excludes Bangladesh, Bhutan, and Laos since data for these countries are incomplcte. (4) Figures in parentheses refer to the estimated enrollment ration if students abroad are included. They are shown only for Malaysia and Sri lanka, countries with sizable student populations abroad. 1.49 An expanded higher education system does not necessarily have to use more public funds. Indeed, there need not be any budgetary implication at all for the expansion of the private sector beyond that of establishing an office of accreditation. Given the current, regressive, nature of subsidies to higher - 24 - education (Table 1.15), an increase in fees in public institutions which would be able to cover such a modest extra cost and would not sacrifice the government's concerns with equity in service delivery. These issues were discussed at length in a previous reportf'. This is also the theme of the proposed GOM-Bank sector study in higher education. 1.50 In addition to improved higher education, the government will need to improve the quality, as well as increase the capacity, of skill training programs in the country. This is taken up in Chapter 4 below. Table 1.15: Proportion of Federal Subsidy on Education Received per QuintUe of Household per Capita Income Quintile 1 2 3 4 5 1973 Primary 28% 22% 22% 18% 9% Secondary 19% 20% 24% 19% 18% Higher Ed. 3% 6% 19% 19% 51% 1984 Primary 34% 27% 20% 12% 8% Secondary 29% 26% 21% 15% 8% Higher Ed. 7% 13% 17% 35% 28% 1989 Primary 36% 27% 18% 12% 7% Secondary 31% 25% 20% 14% 9% Higher Ed. 10% 15% 21% 31% 24% Source: 1973, Meerman, 1984 and 1989, Malaysia Household Income and Expenditure Survey. F Fiscal Reform for Stable Growth, World Bank, Report No.10120-MA, April 1992. - 25 - Appendix lA: Zstimates of Labor Supply and De^mnd 1. In order to assess alternative explanations for the differential growth rate of wages between skilled and unskilled workers, a system of supply and demand equations for labor was estimated. The purpose of the analysis was to distinguish between and assess the relative contribution of the three explanations for differences in the evolution of wages as discussed in the text: 1) differences in the demand for types of labor due to increases in the capital stock 2) differences in supply elasticity of labor 3) differences in demand elasticity of labor 2. The data available for this purpose are the annual surveys of manufacturing. For each of the subsectors in manufacturing, time series data exists for wages and labor use of four categories of workers: managerial and technical, skilled, semi-skilled and unskilled. In addition, information is available on the value of fixed assets and prices of output. Data for seven years (1985 - 1991) for each of the twelve manufacturing subsectors was used, giving a panel structure to the data. The underlying assumption is that there is a common structure for supply and demand of labor for each of the subsectors. 3. The equations of estimation for each type of labor (indices are ignored) are as follows: Supply: log(L.') a v . log(Wl + ) 2 log((4t) + *, Demand: log(LD) = a + b1 . log(Wpe) + b* log(P'l) + b3 * log(K't) + *lit where: Lk - Labor supply in sector i, time t Wi' . Real wage (deflated by the consumer price index) in sector i, time t W - Average of the real wage in all other sectors' for the same type of labor LA a Labor demand in sector i, time t WO . Real wage (deflated by output price in i) Pi - Output price K4 a Value of fixed assets 4. The coefficient on the wage in the supply equation (for any level of aggregation) is the supply elasticity of labor to that subsector of manufacturing. If all wages in manufacturing were to rise together (as would be true in a competitive labor market), the net supply elasticity to manufacturing would be the sum of the two coefficients in that equation. This number could be - 26 - higher than ordinarily assumed (often near zero for overall labor supply) since this is still only a subset of jobs (only manufacturing) at each skill level. 5. Estimation of the supply and demand equations (with the additional equilibrium condition that supply equal demand) was done with the two stage least squares technique. The supply equation is identified by output prices and real assets (from the demand equation), demand equation is identified by consumer price deflated wages in the other sectors (from the supply equation). 6. Different levels of aggregation were examined: 1) for each of the four types of labor separately 2) for an aggregation into high skilled (managerial, technical and skilled) and low skilled (semi-skilled and unskilled) workers 3) for the aggregate of all workers Results 7. The equations for the three levels of aggregation are presented in Tables l.Al and 1.A2. Results will be discussed primarily in terms of the second level of aggregation - high versus low skilled workers. Estimates tended to be more consistent and stable the higher the level of aggregation For the most aggregate model (column 1), the supply equation is highly significant and makes perfect sense. The own wage supply elasticity is very high (and positive) while the cross price (with other sectors) wage supply elasticity is also very high (and negative). That is, increases in the wage in each subsector induces a substantial supply response into the sector and higher wages outside the sector induce workers to leave for the better opportunities. 8. For the more disaggregated models, the basic story remains the same though the cross price effects seem to be less stable. However, since the main hypothesis (that labor at different skill levels have different supply elasticities) could only be tested in disaggregated models, attention must turn to them. 9. The main coefficients of interest are those on sector wages in both the supply and demand equations and on fixed assets in the demand equation. Faster wage growth in the high-skill sector (the fundamental fact we wish to explain) can be due to lower supply elasticities in that segment of the labor market, lower demand elasticities and higher elasticity of demand with respect to investments. 10. As for the supply elasticity, it is noteworthy that the higher the skill level, the lower the labor supply elasticity. This is true in the model with two skill levels as well as that with four. In fact, in the four skill level model, the supply elasticity of the highest skill level cannot be distinguished from zero while that on the lowest skill level cannot be distinguished from infinity, i.e, the case of fixed real wages (the inverse of the coefficient cannot be distinguished from zero). 11. It is also the case that demand for skilled workers is less elastic with respect to wages than is demand for unskilled. This can be due to greater - 27 - complementarity with respect to advanced machinery and (as is found in developed country contexts) greater substitution between labor and energy intensive techniques at the lower skill levels. In any case, the relative contribution of supply and demand needs to be examined more closely. 12. The one hypothesis which can be rejected is that the wage differentials between high and low skilled is due to greater demand for high skilled workers as a result of investments. The demand equations indicate that investments in fixed assets increase the demand for unskilled workers more than for high skilled. 13. In order to assess the relative contribution of the various components of wage growth and delineate some policy implications, Figure lA.l below is useful. The figure consists of two demand curves and two supply curves corresponding to skilled and unskilled workers. The curves are based on the estimated demand and supply elasticities reported in Table lA.1. Note that consistent with the estimated elasticities, both demand for and supply of unskilled workers is flatter than the demand for and supply of skilled workers. The implication of this for the labor market outcomes is as follows. Starting from some initial equilibrium (point A), the market for skilled workers clears at point B and for unskilled workers at point C. These points show that wage growth of skilled workers is much higher and employment much lower than that of unskilled workers. Now if policy intervention improves tertiary education and upgrades skills of the labor force, thus reducing the difference between skilled and skilled workers, the new supply curve would lie between the two older supply curves. This will result in new market equilibrium points D and E. The new equilibria show that employment of skilled workers increases and the difference in wage growth between skilled and unskilled workers disappears. Wages 5 4 5 Demand-Skilled 3 Supply-Skilled 2 D emand-Unskilledd Supply-Unskilled 0 2 4 6 8 10 12 Employment FIG 1A.1 - 28 - Appendix 13: Investment Rates and Skilled Wages 1. As described above, investment in fixed assets were the driving force in increased demand for, and wages of, wages in the recent period. However, we can ask the reverse question: how have investment rates responded to the increased wages themselves. Specifically, have the higher wages in skill- intensive segments of the labor force had a dampening effect on investment levels? 2. The same data as in the labor supply and demand model can be used to examine this point. The variable to be explained is changes in fixed assets (i.e., investment) by subsector in manufacturing by year. The explanatory variables are lagged wages in skilled and unskilled sectors, lagged prices of output and, as an exploratory feature, the lagged share of skilled workers and the interaction of the share and the wage of skilled workers in each subsector. The idea is to see if wages depress investments and if this effect is greater for higher skill wages. 3. The results are in table 1.A3. While not exceptionally strong, the results indicate that higher wages for highly skilled workers do have a depressing effect on investment while low skill wages do not. This is consistent with the survey data presented in the text which identified the difficulty of obtaining skilled workers as an important deterrent to foreign investment. The same appears to be true for investments from all sources. - 29 - Table IA.I: Labor Supply and Demand Estimates Wage * Competing Output Fixed RI Wage Price Assets Manufacture Workers Supply 6.54 -5.55 .73 (2.09) (2.17) Demand -.828 .105 .486 .98 (.223) (.181) (.059) Managerial, Technical, Skilled Workers Supply 5.108 .892 .869 (2.51) (2.16) Demand -2.14 -.383 .669 .893 (.094) (.286) (.069) Semi Skilled, Unskilled Workers Supply 24.04 -7.55 -.05 (14.8) (7.48) Demand -4.64 -3.06 1.03 .78 (2.37) (.652) (.28) * Deflated by CPI in Supply equations Deflated by sector's Producer Price index in Demand equations (Standard errors in parentheses) - 30 - Table 1A.2: Supply Estimates: Disaggregated Labor Categories Wage Competing Wage Managerial and Technical -18.13 19.8 -.15 Workers (31.4) (28.4) Skilled Workers 6.32 2.43 .83 (3.55) (2.33) Semi Skilled Workers 11.58 -2.60 -.15 (6.49) (3.77) Unskilled Workers 26.59 -2.32 -.71 (32.14) (9.48) (Standard errors in parentheses) - 31 - Table 1A.3: Investment Equations [K I Dependent variable: log i-0 K = real value of fixed assets tK-1J Independent variables: log (Skilled log (Unskilled log (Skilled (3)*(2) log (Output R2 wages)-, wages)-, share of price)-, employment)-, (1) (2) (3) (4) (5) -.091 .061 (.043) -2.13 .326 .385 .083 (1.08) (.220) (.237) -.473 .488 -1.38 .137 .486 .089 (.212) (.247) (.63) (.088) (.255) (Standard errors in parentheses) X-1 = lagged value of X - 32 - II. NONWAGI COSTS OF LABOR Introduc:ion 2.1 Nonwage costs of employment are often neglected in otherwise comprehensive labor market analyses. Recent evidence from OECD countries indicates that this may be a critical omission. Samuelson (1994) reports that nonwage expenses -- mainly payroll taxes and fringe benefits -- often represent half of total labor costs. These are 52 percent in Italy, 46 percent in Germany, 39 percent in Spain, 28 percent in the U.S., and 24 percent in Japan. In France, payroll taxes alone are more than 40 percent of wages. It is not coincidental that with roughly equal populations, while the US generated 41 million jobs since 1970, the European Community created only 8 million jobs, mostly in the government sector, since that year. 2.2 Reassuringly, this report estimates that average nonwage -osts in Malaysia are between 20 and 25 percent of wages, but intersectoral varieitions in this ratio are disconcerting. While this ratio varied between 15 and 20 percent in manufacturing between 1985 and 1991, the plantation sector had a ratio exceeding 45 percent. The performance of these sectors in job creation is eerily similar to international differences referred to above. While job creation is not an overriding concern in Malaysia today, nonwage costs cannot be ignored because of links between performance-based nonwage compensation (such as bonuses) and labor productivity. Malaysia's aspirations to make the transition from income growth based on employment increases to growth based on productivity increases implies that the composition of total nonwage cost (not just the level) becomes an important variable to monitor. Additionally, foreign direct investment depends critically on unit labor costs, which in turn are a composite of wages, nonwage costs, and productivity. 2.3 Also worrisome are the trends in nonwage costs. The Figure 2.1 below shows that the ratio of nonwage costs to wages in manufacturing remained below 15 percent between the period 1985 to 1990. In 1991, the ratio jumped to 17 percent.1' With the 1 percent increase in EPF contribution rates effective from 1992, and the 1 percent Human Resource Development Levy for large manufacturing firms in 1993, measured nonwage costs in manufacturing are likely to be more than 20 percent today. 2.4 The issues of interest regarding nonwage costs can be grouped into three broad categories: The first set consists of payroll levies for the purposes of providing social (old-age) security and occupational hazards insurance, especially those relating to intersectoral differences in effective rates of these levies. The second set of issues relate to mandated and l' While a significant proportion of this increase was due to the rapid increase in the ratio of nonwage to wage costs in food products and processing (sector 311), figure Al in the annex shows that 15 out of 20 subsectors experienced an increase in this ratio during 1991 relative to the 1985-90 average, while only 5 experienced declines. - 33 - collectively bargained fringe benefits such as housing, bonuses, and allowances, in particular, differences across sectors and worker-types in nonwage costs of employment (e.g., the asymmetries in employing female versus male workers, and in employing domestic versus foreign workers). The final, possibly the most critical, set of issues relates to the use of nonwage compensation as a device to keep labor costs flexible in the face of changing trends in foreign competition, cyclical fluctuations and unionization; in particular, the use and legal treatment of bonuses, overtime wages, and other incentives. NONWAGE COSTS AS A FRACTION OF WAGES MSnufJctLrSin Roctor, 1BS5-.9910 17.6 17,4- 17.2- 17 16.8 16.6 16.2 16. L 15.G0 15.6 15.4 15.2 14.8 14.6 14.2 19J I 197 19b9 I iSbi 1977 10 190 Yomr Figure 2.1 2.5 Payroll taxes, such as employers' contributions to EPF, SOCSO, and HRDF which are proportional to wages, are mandated by law, so the main issue is that of compliance. Fringe benefits, consist of housing and health benefits, allowances, retirement benefits, and leave, and are generally not proportional to wages. These can be mandated by law or negotiated as part of individual or collective contracts. The third component of nonwage benefits are other rewards to work, such as bonuses and overtime payments, which are usually proportional to wages. These are generally negotiated as part of individual or collective agreements or used as incentives to tie productivity with total compensation. 2.6 In the following pages, a brief quantitative summary of nonwage costs in Malaysia is provided. It is usefil for this purpose to distinguish nonwage - 34 - costs that are proportional to wages, and those that are nonproportional to wages. In the former case, the proportionality quotients may vary across time and sectors. Nonwage costs that are not proportional to wages, such as fringe benefits, are more difficult to study. Nevertheless, an effort is made here to provide a comprehensive picture of the cross-sectoral variations in these costs over time. Finally, a hitherto unexamined establishment survey of the manufacturing sector is analyzed to determine the factors influencing the adoption of bonuses and flexi-wage schemes as instruments of tying compensation to performance. A. Social Security and Other Payroll Levies 2.7 Employer contributions to the EPF, raised from 11 to 12 percent of payroll in 1993, have become a topic of lively debates in both the private sector and the government. While these contributions almost certainly raise the cost of employing labor, the government has traditionally used these funds to keep the cost of public borrowing low. This implies that the EPF can be used to alter capital-labor ratios. Since one of the objectives of the Malaysian government is to encourage the adoption of labor-saving capital-intensive techniques, this policy seems to be consistent with the Government's goals. However, private sector employers seem concerned about the contribution of EPF and other payroll levies to labor costs in a tightening labor market, and the implications for Malaysia's international competitiveness. 2.8 From a domestic policy point of view, therefore, employer contributions to the EPF can be thought of as raising labor costs relative to capital costs; the net effect on the economy may be consistent with the government's goal of fostering higher productivity by increasing the capital- intensity of production. From an open economy viewpoint, though, there are two additional concerns. First, to the extent that mandated EPF contributions (and other payroll levies) raise the cost of labor, this will affect the international competitiveness of the Malaysian export and import-competing sectors.Y That is, increasing labor costs will serve as a deterrent to the outflow of goods. Second, given the Government's objective of an export-oriented push towards developed economy status, this implies that foreign capital must be attracted regardless of total domestic savings and investment ratios. Increasing costs of labor will serve as a deterrent to the inflow of foreign capital and knowhow. Since the Government perceives the need for labor substitution most in services and construction, both of which are largely nontradables, there may be some potential for both encouraging labor-substitution and foreign capital inflows. This potential decreases as the labor market becomes more and more competitive (as it has): in a unified labor market, capital-labor ratios in the tradables sector cannot be determined in isolation of the developments in the nontradables sector. Y It is beyond the scope of this study to definitively answer whether EPF contributions raise the cost of labor one-for-one, or whether workers view these contributions as postponed wages and hence can be paid less than they would accept if employer EPF contributions were reduced. An earlier World bank study on Social Security provides some lessons for the management of contributory schemes. (See Box 2.1 for ......) - 35 - Payroll Levies in Malaysia 2.9 Table 2.1 below summarizes payroll levies in Malaysia. The main payroll levies are employer contributions to the EPF (12 percent of wages), SOCSO (1.75 percent of wages), and HRD fund (1 percent of payroll for manufacturing firms with more than 50 employees). While it cannot be determined whether the tax rate is too high or too low, it is clear that there are substantial variations in definitions of what constitutes the tax base for these payroll levies. Table 2.2 summarizes the differences in definition across the four main statutes governing payroll levies. Even within the Employment Act, there are four separate definitions of wages. Employers seem unanimous in pleading for greater uniformity in defining "wages", so that it becomes less cumbersome to compute the taxes owed. Intersectoral Differences in Incidence of Payroll Levies. 2.10 There is considerable evidence that the incidence of payroll levies differs both across and within sectors. For example, while theoretically uniform at 12 percent, EPF coverage differs across sectors depending upon the proportion of self-employed and foreign worker -- for whom the contribution is optional -- and of the relative importance of small-scale entrepreneurs and contracted labor, for whom the levy is difficult to enforce. Table 2.3 below presents the approximate proportions of employees actively contributing to the EPF. 2.11 These numbers should be cautiously interpreted. It would be inaccurate, for example, to interpret these numbers as sectoral indicators of the extent of evasion of payroll taxes: these numbers need not equal 100 percent even if there is no evasion of the tax, since contribution is voluntary for the selfemployed, for foreign workers, and for civil servants with more than ten years of service (since they are eligible for government pensions) . In agriculture, where selfemployment may be the rule, less than 25 percent of workers contributed to the EPF in 1992. Thus, for example, only about 20 percent of workers in construction -- where foreign workers are a large fraction of total employment3' -- are active members in the EPF. One-third of all civil servants do not contribute, implying that they have qualified for the government pension program. 3/ Official estimates of the share of foreign workers in manufacturing range from 3-5 percent of sectoral workforce; that for construction is about 70 percent (Midterm Review of the Sixth Malaysia Plan, 1993). - 36 - Table 2.1: Nonwage Costs Proportional to Wages, Various Sectors SCHEME COVERAGE MIvEMBERSHIP RATE Number (Year) (SO) (Nlillions) Emplovee Provident All employees aged Fund (EPF) 16-55 years with (a) Employer contracts: mandatory 1952 - 1974 for private sector 0.07 (1974) 5.00 1975 - 1979 0.10 (1979) 7.00 1980 - 1992 0.21 (1992) 11.00 1993 -present 0.22 (1993) 12.00 (b) Employee 1952 - 1974 2.48 (1974) 5.00 1975 - 1979 3.54 (1979) 6.00 1980 - 1992- 6.62 (1992) 9.00 1993 - present 7.02 (1993) 10.00 Employees' Social All employers with more Security (SOCSO) than 5 employees; all employees (a) Employer earning less than RM2000 (i) Empluyment Injury per month: casual employees 1.25 (ii) Invalidity Pension are not covered; all 0.50 (b) Employee production employees (i) Employment Injury are covered regardless 0.00 (ii) Invalidity Pension of camings level. 0.50 Human Resource All employers with 50 Development Fund (HRDF) or more employees in (a) Employer the manufacruring 1.00 (b) Employee sector 0.00 Government Pension 'Pensionable' govemment Scheme employees, usually with (a) Employer more than 10 years of Defined Benefits (b) Employee scrvice. Noncontributory Private Provident Employees in selected Funds occupations and companies (a) Employer e.g.. teachers. Variable (b) Employee Variable Sources: EPF Bulletin (1992), Asher (1993). - 37 - Table 2.2: Differences In Tax Base for Various Payroll Levies Component of Pay Employment Act EPF Act SOCSO Act HRDT Act 1955, as at 1985 1991 1969 1992 Basic Definition of All remuneration All Money All Money Basic salary & fixed Wages Remuneration Remuneration cash allowanc Overtime Include Deduct Include Include Bonuses and Deduct only Include Deduct Deduct Commissions Noncontractual Gratuity on Discharge Deduct Deduct Deduct Deduct or Retirement Service Charge Deduct Deduct Include ? Retirement Benefits, Deduct Deduct Deduct Deduct Pensions, Provident Fund Travel Allowance or Deduct Include Deduct Deduct Travelling Concession Compensation for Job- Deduct ? Deduct Deduct related Expenses Note: "?" implies the treatment is unclear. Sources: Employment Act, 1955 (as in 1985), Employees Provident Fund Act, 1991, Human Resource Development Act, 1992. & Employees' Social Security Act, 1969 (as in 1992). 2.12 The ratio also varies because of variations in the degree to which subcontracting is practiced. While subcontracting may be the efficient form of employment where it is difficult for the principal to monitor the effort or output, subcontractors are also more difficult to police. The more troubling statistics are for manufacturing and transport and communication. Less than 50 percent of workers in manufacturing, and less than 25 percent in transportation and communication are active contributors. These are the sectors where enforcement efforts should be concentrated. These efforts should especially target the manufacturing sector, where official figures indicate that only about 5 percent of workers are foreign. 2.13 Additionally, some payroll taxes, such as the human resource development levy, are levied only on the manufacturing sector, and within the manufacturing sector, only for large firms. Even for similarly sized firms within a sector, nonwage costs can differ across workers. The main differences are for domestic versus foreign workers, and contract versus directly employed workers. Poor enforcement of payroll levies for contract labor may result in distortions in contract-type, with adverse efficiency and equity effects. Nonwage Cost Differences Between Foreign and Domestic Labor 2.14 Nonproportional and erratically enforced foreign labor taxes, combined with exemption of foreign labor from employer EPP levies may distort the use of - 38 - foreign labor. Foreign labor taxes, examined in more detail in chapter 3, have both a fixed and a roughly proportional component. Annual levies on foreign workers plus medical examination fees are about RM 500, which is between 10 to 15 percent of the annualized wage of a worker (for semi-skilled and unskilled workers respectively) in the plantation sector, but only about 8 to 12 percent of manufacturing wages (for semi-skilled and unskilled workers respectively). Payroll levies for domestic workers, on the other hand, are about 15-20 percent of wages. In the manufacturing sector, for the same money wages, this results in a nonwage cost advantage of hiring foreign labor of about 5 percent for unskilled workers, and about 10 percent for semi-skilled workers. That is, given the large fixed component of levies on employment of foreign labor, the gap in nonwage costs increases with wage in both the manufacturing and the plantation sectors, creating a stronger incentive to hire semi-skilled rather than unskilled foreign labor. The cost advantage is less in the plantation sector, but the costs of employment by plantations include housing and hospital benefits (more on this in the section on fringe benefits). 2.15 In the construction sector, employers avoid the burden of payroll taxes by hiring labor through labor contractors. Enforcement of payroll levies on contractors is difficult for these contractors: there is often no formal establishment address, and there is some confusion on the interpretation of the law between what constitutes a "contract for service" -- which makes the contractor liable for employer shares of payroll taxes and a "contract of service" which leaves the burden of taxes on the principal employer. Construction labor is overwhelmingly foreign (estimated to be about 75 percent of construction employment), and any scheme advocating the extension of payroll taxes to foreign workers must be accompanied by steps to facilitate enforcement of payroll taxes on contractors. 2.16 In general though, it appears that while administrative policies have in the past restricted imports of semi-skilled foreign labor, economic incentives created by employment-related taxes inadvertently encourage it. - 39 - Table 2.3: Sectoral Differences In EPF Coverage Sector Active Members Total Employment Percent Covered Agriculture, Forestry & Fishing 455.2 1837.6 24.8 Mining & Quarrying 25.2 39.1 64.4 Manufacturing 613.3 1290.2 47.5 Construction 89.3 426.9 20.9 Public Utilities 33.1 45.9 72.1 Transportation & 70.9 285.4 24.8 Communication Services 1430.6 1845.7 77.5 Government Services 574.3 850.2 67.6 Total 3436.9 6612.0 52.0 Sources: Statistical Bulletin, 1992, Employees Provident Fund. Labor Indicators, 1991, Ministry of Human Resources. Notes: Agriculture etc. includes agricultural products requiring processing; Services includes commerce and services. Recommendations 2.17 The first recommendation is that the definition of the tax base (payroll) be made uniform for the EPF, SOCSO, and HRD levies, so that it is administratively easier to calculate the dues. Relatedly, the rebate for training costs should be made less distortionary by making it uniform for all types of training. Variable rates presume that the HRDC knows better than individual employers what is beneficial for them, unlikely in a sophisticated and dynamic economy such as Malaysia. 2.18 The second recommendation is that the EPF redouble efforts to reduce evasion of contributions by employers. In particular, the incentive to subcontract workers should be eliminated by expanding the enforcement machinery, especially for contractors and employment agencies, and removing the distinction between contract-of-service and contract-for-service. Since this is a difficult task, it may be necessary to restructure the EPF, possibly by spinning off the investment functions to the private sector. A recently completed World Bank study on Social Security provides some lessons for the management of contributory schemes. (See Box 2.1 for the experience of Chile with private management of provident fund contributions). 2.19 The third recommendation is that the employer contribution rates not be raised in the near future, since this will increase the incentives to evade the levy altogether. Analysis of EPF data between 1961 and 1993 (reported in annex Table 2A.1) indicates that increases in employer contribution rates are negatively related to total EPF contributions, when other influences such as employees, contribution rates, the real rate of return to EPF deposits, and the - 40 - number of contributors are controlled for. In stark contrast, expanding coverage of employers (and employees) is associated with significant gains in total contributions.y For both budgetary and efficiency reasons, therefore, this report advocates expanding coverage of payroll levies, especially targeting the manufacturing and transport and communication sectors. Box 2.1 CHLE'S PROVIDENT FUND: THE SUPERIORITY OF PRIVATE MANAGEMENT? A recent survey of social secunty systems around the world documents that among publicly managed mandatory savings schemes in the 1980s, the average anmial real investment returns were 5.0 percent for Malaysia (1984-88), 3.2 for Singapore (1980-89), and 0.3 percent for India (1980-1990). It seems that the EPF has done well relative to other countries with similar systems. In sharp contrast, however, the average return for Chile's funds (AFPs), which allow workers to pick the management company for their own funds, was 12.6 percent (1981-90). While there are considerable year-to-year fluctuations, and the net retums may be lower because of fees and commissions, giving workers this choice also facilitates administrative simplicity: unlike Singapore and Malaysia, Chile does not allow withdrawals for housing, education and other personal purposes. From all accounts, workers are quite satisfied with the publicly administered- privately managed system. The scheme also has positive allocative efficiency effects since the government must compete for funds, rather than being assured of cheap funds from a forced savings pool. As in 1991, 40 percent of AFP funds were in state securities, 32 percent in corporate securities and bonds, and 14 percent each in mortgage bonds and bank deposits. AFPs have also invested heavily in the privatization of public utilities in the mid-1980s, accounting for 10 to 35 percent of the equity capital of privatized utilities. Source: Income Security for Old Age, World Bank (1994). ' The analysis also shows that the real rate of return is not significant in determining total contributions, indicating the forced or inframarginal nature of savings generated by the scheme. - 41 - 2.20 The fourth recommendation is that the HRDF levy should be extended to sectors other than manufacturing, which will reduce the intersectoral differences in payroll levies. This could be accompanied by a simplification of the rules regarding recovery of training costs for contributors to the HRDF. In particular, recovery should be uniform for all types of training. 2.21 The fifth recommendation regarding payroll levies arises from the finding that sectoral EPF coverage is negatively correlated with the relative importance of foreign workers in the sector. Since this creates a perverse incentive to hire foreign labor, especially for highly paid jobs, we recommend that payroll levies be extended to include foreign workers. Employee contributions can be individualized, and returned as a lump-sum payment when the foreign worker is repatriated. Employer contribution rates can be used to strengthen the administrative capacity of the immigration department, so that applications to bring in foreign workers can be processed quickly, as can applications to renew licenses to employ foreign workers. The underlying principle for levying the same overall EPF levy (22 percent) for foreigners as for domestic workers is to remove any artificial incentive to hire foreigners rather than Malaysian workers. The rationale for foreign workers' access to their individual contributions -- payable upon their final departure from Malaysia -- is to create an incentive for foreigners to leave the country when their wages fall. The rationale for using employer contributionB for institutional strengthening is to reduce the incentive to hire foreign workers illegally; employers claim that if the time for processing their applications to hire foreigners is reasonable, they would not hire illegal immigrants. B. Fringe Benefits 2.22 Malaysian employers are both required by law and otherwise provide considerable fringe benefits to their employers. In analyzing fringe benefits, a simple rule is that while fringe benefits paid to non-executive employees are mandated by law (largely through the Employment Act, 1955, which applies to only production workers and nonproduction workers who earn less than executive-level salaries) or negotiated in collective agreements, fringe benefits received by executives are generally negotiated individually. Table 2.4 below summarizes the mandated benefits under the Employment Act. 2.23 Figure 2.2 below shows the compliance to the Employment Act by 900 manufacturing and non-manufacturing firms studied by the Malaysian Employers Federation in 1993, and non-mandatory benefits offered by firms to both non- executive and executive employees. All firms offer paid annual and sick leave, and almost all allow extended hospitalization leave. All firms offer paid maternity leave for women, while about 2/3rds of all firms offer paternity leave. Allowances offered include those for medical consultations and hospitalization (almost 100 percent of firms), overtime allowance (mandated for non-executive workers, with 20 percent of firms offering it for executives), Sectoral Differences in Mandated FrinQe Benefits 2.24 Nonwage costs are about 20 percent of wages in manufacturing, but more than 40 percent in the plantation sector. The difference is largely attributable to mandated housing and medical benefits. These mandates were in response to - 42 - poor health and living conditions in the plantations, and were perceived to be necessary for political and social stability during the 1960s and 1970s. More recently, though, the plantation sector has moved from reliance on family labor to single -- often foreign -- workers." As the labor force in the plantation sector undergoes a demographic transition -- from domestic family labor to foreign and single workers, these benefits compensate less and less for the relatively low wages that necessarily accompany relatively high nonwage costs. This in turn implies that the ability of the plantation sector to retain or attract workers becomes weak relative to sectors where these benefits are not mandated, say services or construction. Mandated fringe benefits imply that the plantation sector cannot pay high wages, and hence be disadvantaged relative to other sectors. This reasoning is consistent with the "revolving door" nature of the sector for foreign workers who use the sector as an entry-point to employment in services, manufacturing and construction, since these relatively unregulated sectors can afford to pay higher money wages. ;' It is estimated that at least 30 percent of workers in plantations are foreigners. There also is anecdotal evidence that the mean age of plantation workers has fallen, and so has the percentage of plantation workers who are married. - 43 - Table 2.4: Nonproportional Nonwage Benefits Under Employment Act, 1955 (Incorporating Amendments In 1989, as in 1992) Benefits Tenure of Employee Coverage 5 Years Years Years 1. Paid Leave (days/year) All production workers earning less than RM 1250 per month Annual 8 *T 8 12 16 Sick For non-work-related episodes. Work-related infrmities covered - Not Hospitalized 14 14 18 22 under Workmen's Compensation Act, 1952. - Hospitalized 60 days regardless of tenure Total paid leave for sickness and hospitalization not to exceed 60 days annually. 11. Maternity (days/birth) 60 days regardless of tenure All female production employees or those earning less than Rm 1250/month, who have fewer than 6 surviving children. 111. Severance (days) 0 10*T 15T 20*T No benefits for resignations IV. Spec,,al Benefits Only for Plantation Sector - Marndated Housing enterprses with more than employees - Heatth Facilities Source: Employment Act 1955 and Regulations Made Thereunder, Malaysian Employers Federation, 1993. Notes: T is tenure in years. The rate of pay is generally the ordinary wage rate, or a stipulated minimrum wage if the ordinary rate of pay is below this. 2.25 Just as unionization is known to have a wage effect, it may also affect nonwage compensation such as fringe benefits. Both plantation and manufacturing sector workers are relatively unionized, and collectively bargained for norwage benefits are relatively high in this sector. However, legally stipulated fringe benefits in the plantation sector result in a higher nonwage to wage ratio than in manufacturing. The Additional Costs of EmDlovina Women 2.26 The main issues of policy interest relating to the employment of women are the gender differences in mandated fringe benefits of Malaysian workers, and whether labor laws affect the employment of women due to nonwage cost differentials. The main components of compensation that drive a wedge between the costs cf employing men and women are entitled maternity leave and allowances. Under the Employment Act, a female employee is entitled 60 consecutive days of paid maternity leave for each pregnancy, as long as she has fewer than 6 surviving children. The allowance must be the higher of the ordinary rate of pay - 44 - or RM 6 per day (in 1990).5' Women with 6 or more surviving children are entitled to 60 days maternity leave without allowance. 2.27 The employment of women is also restricted by the following additional rules: First, women cannot be employed for underground work. Second, women cannot be required to work, without special exemption, in industrial or agricultural work, between 10 p.m. and 5 a.m. Third, women cannot be dismissed from work four months before confinement due to pregnancy, and for absence from work for upto three months after expiration of maternity leave. Finally, women cannot be required to commence work for the day without having had 11 consecutive hours free from such work. The first three laws can be justified on grounds of special circumstances of women relative to men, and occupational and related safety. However, the law stipulating that women cannot be required to work within an interval of 11 hours of stopping work for the day may be needlessly restrictive for both workers and employers. 2.28 It is quite likely that the gender wage differentials (reported in Chapter 1) reflect these differences in nonwage benefits. Given the relatively liberal mandated maternity benefits and restrictive employment laws for women in Malaysia, it is probably not coincidental that the male-female wage differences are large compared to most other East Asian countries. While investments in education and diminished fertility have led to increases in wages for women, the aggregate gender wage gap in Malaysia remains the highest in the region. Z' There is also evidence that employers have hired fewer women in Malaysia relative to other East Asian countries between the period 1975 and 1987 (Figure 2.3 below). In addition, Figure 2.4 below shows that the share of women in incremental employment between 1975-1987 is lower in Malaysia relative to Singapore, the Philippines, and Thailand for all occupations, and even to Korea (well-known for a very unfavorable labor market for women) for occupations other than managerial and professional. The reluctance of employers to hire women is in turn likely to diminish the incentives for women to seek market work in the first place. It may not be coincidental that female labor force participation rates in Malaysia have stagnated at less than 50 percent (for all three ethnic groups, weakening cultural explanations) while those of other East Asian countries -- with the exception of Japan -- have increased significantly. 2.29 In fact, there is some evidence that mandated maternity benefits (paid leave) are considerably less generous in the Philippines (45 days), Thailand (60 days, but only for firms with more than 20 employees), and Korea (where maternity-related laws are not enforced). Besides, tenure requirements for eligibility for maternity benefits are also considerably lower in Malaysia relative to most other East Asian countries. Malaysia's newest competitor, f The conditions for qualification are that the woman must be in employment for at least one day in the four months preceding confinement, and at least 90 days during the nine months preceding confinement. 2' The aggregate female-male wage ratio in Malaysia was estimated to be about 50 percent in 1990. The respective female-male wage ratios in other East Asian countries between 1988-1990 were Thailand (90 percent), Philippines (74 percent), Japan (59 percent), Korea (51 percent), and Indonesia (49 percent). - 45 - China, has both higher female participation and -- given China's significantly lower fertility rates -- much lower maternity-related costs of employment. Recommendations 2.30 The first recommendation is that mandated housing!' and medical benefits for the plantation sector be reduced or eliminated, so that intersectoral variations in fringe benefits reflect economic rather than legislated differences. Fringe benefits can vary across sectors for reasons such as the size distribution of firms and the nature of work, which result in sectoral differences in the wage-nonwage composition of remuneration for work. While these differences reflect adjustment to differences in industrial structure, making fringe benefits mandatory may rob the system of flexibility and hence efficiency. Nowhere is this more evident than the Malaysian plantation sector. These changes warrant the repeal of laws mandating housing and other fringe benefits for the plantation sector. 2.31 The second recommendation is that mandatory maternity allowances be re-examined, while leaving intact legislation that protects women from being dismissed or laid off due to reasons related to childbearing. Maternity benefits required by law are quite generous. While the desirability of these benefits cannot be determined by economic considerations alone, their existence make it difficult to determine whether higher labor force participation by women is constrained by the higher costs of employing women relative to men, or whether the constraints lie elsewhere. Rapid decreases in fertility rates during the last decade may have diminished the desirability of generous mandated maternity leave and benefits, while employers may continue to view women as relatively more costly to employ, leading to a downward "adjustment" in the wage component of compensation. Labor force participation rates of women -- after registering moderate increases -- have stagnated at levels significantly below those of other countries in the region. If the wage-effect on female labor force participation is greater than the effect of nonwage compensation on the decision to participate in market work, then these mandated nonwage benefits may be inhibiting fuller utilization of an increasingly scarce resource in Malaysia -- skilled domestic labor. The option of providing creches located conveniently to the place of work also needs to be examined. International experience suggests that such arrangements reduce the time women take off for childbearing and can be quite cost-effective. 2.32 The third recommendation is that the stipulation in section 34 of the Employment Act of 1955 -- that women cannot be required by employers to "commence work for the day without having had a period of eleven consecutive hours free from such work" -- should be deleted, since it is unlikely to benefit either workers or employers. Such restrictions may be a barrier to employment of women in dynamic sectors which need to respond swiftly in an increasingly competitive global environment. While special laws are needed to ensure a safe work environment for women, some changes in the Employment Act are periodically required to respond to changing expectations of women and men in household work. !'Housing is mandatory in the sense that refurbishing of houses is required by law. - 46 - FIRMS OFFERING FRINGE BENEFITS, 1993 Manufacturlng & Nonrmnutacti-ring Flrmr 110 100- 90- ?0- 50 40 30 20 10 0 SICIK MatQrnrty8QnQ!C0nsult. Ovrrtltro rnift AI l Tyvg of 2QnQf It ENon-Execut lve rExecutlvQ Figure 2.2 SHARE OF WOMEN IN INCREMENTAL EMPLOYMENT All Occupations, 1975-1987 so 50 40 w o 30 Er 20 Maleygla Honrgong rorfa Thalland PhiMlpolnoo Singapore COUNTRY Figure 2.3 - 47 - SHARE OF WOMEN IN INCREMENTAL EMPLOYMENT Various Countries, 1975-1927 1so z w uJ 0 tA ^A b Poresional Clerical Servico Me.agerll ahles OthWr OCCUPATION MIhlysla I Ph I IIppInes S1ngapore F Thalland I Korea Figure 2.4 C. Work Incentiveg. unions and Employment Flexibility 2.33 Malaysian employers use bonuses, overtime, and other nonwage incentives to retain flexibility in wages and employment, and to lower turnover. While bonuses have a component that is collectively bargained, more than half of bonuses paid in manufacturing in 1992 were incentive-based;; in services this fraction is higher. Similarly, employers have incentive-, and tax-, and flexibility-related reasons to pay workers overtime premia rather than higher base wages. Employers argue that this allows them to keep on workers during times of adjustment. Figure 5, based on a 1993 survey of more than 900 manufacturing and nonmanufacturing enterprises (MEF, 1994), below documents that about 50 percent of firms paid contractual bonuses and about 60 percent paid incentive-based bonuses. Few firms engage in profit-sharing either directly or indirectly (e.g., through share option contracts). "Merit increments," a somewhat misleading term for cost-of-living adjustments, are provided by practically all firms to non-executive workers. These incentive programs are examined in greater depth below. (a) Labor Unions and Bonus Payments 2.34 Bonuses, paid at the end of the year, are an important vehicle for profit-sharing by firms in Malaysia. Table 2.6 below shows that in 1992, bonuses in the manufacturing sector -- the most dynamic of all sectors during the last five years -- were almost RM 6000 for managerial workers, more than RM 2000 for - 48 - technical and supervisory workers, about RM 1000 for clerical and semi-skilled workers and more than RM 600 for unskilled workers. These magnitudes reflect between 1.5 and 2 months of the respective wages. Figure 2.5 below also shows that contractual bonuses were more important for non-executive workers (56 percent of firms offer contractual bonuses to nonexecutives, as compared with 40 percent of firms for executives), and incentive-based bonuses for executive workers (56 and 72 percent of firms respectively).9' 2.35 These numbers help to highlight the important three-way interaction between bonuses, unions, and work incentives that tie earnings to productivity. Since collective agreements generally do not apply to executives (managerial/professional and most technical workers), however, all bonuses paid to this class of workers are likely to be incentive-based. Contractual bonuses, determined by collective agreements between unions representing non-executive workers and management, averaged about 0.85 months. Hence incentive-based bonuses were about 50 percent of total bonuses for supervisory, clerical and other workers in these 86 manufacturing firms. The effects of this on productivity are difficult to measure; but its effects on turnover are relatively transparent. Figure 2A.2 in the annex shows that executive turnover drops within about 4 months of tenure to 0, while that for non-executive workers remains higher than 10 percent (of workforce) for workers with tenure upto 8 months. In an atmosphere of job-hopping and consequent decreases in firm-sponsored training and skill accumulation, incentive-based bonuses are likely to be an important instrument of retention of workers. Nonwage incentives appear to be relatively higher for nonproduction workers, and may be linked to lower employee turnover for nonproduction than for production workers. Any tendency to make incentive-based bonuses a part of collective agreements will likely increase turnover. 2.36 What are the determinants of incentive-based bonuses and contractual bonuses? To answer this question, an analysis was conducted of the responses to a questionnaire circulated to these 86 firms by the Ministry of Human Resources. Table 2A.2 lists results of these estimations. The analysis revealed that for non-executive occupations, the presence of a union generally resulted in a smaller incentive-based bonus, and a greater contractual bonus. The questionnaire design made it difficult for us to distinguish the presence of in- house from industry-wide unions, and makes it difficult to validate or invalidate the claim that in-house worker unions make incentive-based schemes relatively easier to implement.2' The results are, however, consistent with the view that unions can effectively prevent the tying of rewards to performance. 2' The position of industrial courts is that if the bonuses are contractual, the courts will not pressure unions to make them noncontractual, and similarly does not pressure employers to make noncontractual bonus payments parts of collective agreements. This treatment seems correct, and is reflected in good labor- management relations. Lo' Firm size and national origin did not matter. - 49 - (b) The Potential for Introducing Flexi-Wace Systems 2.37 Firms in the manufacturing sector, when asked whether they would consider the introduction of flexi-wage systems, generally responded that they would not. The presence of a worker union and firm size were the main correlates of a negative response. The analysis of survey data reveals that firms are reluctant to introduce flexi-wage systems, for two reasons: First, firms that are not unionized or those that have in-house unions seem to be using bonuses, commissions, piece-rate payments and overtime wages to tie wages to productivity, and to keep wages flexible over the long term. These firms seem to believe the benefits of flexi-wage systems are already captured by their current wage packets. Second, firms that have industry-wide unions are reluctant to introduce these systems because they fear the unions will abort the schemes. 2.38 While it would be unwise to give up efforts to introduce flexi-wage regimes in Malaysian manufacturing, the short-term potential appears to be limited. Firms seem satisfied with wage-setting mechanisms as they have evolved under the current laws. As firms grow larger, tfhe potential diminishes further (since flexi-wage systems often require sharing important information with workers, and this is harder to do with a larger workforce) . The decline of industry-wide worker unions may diminish the reluctance of firms to introduce flexi-wage, but it appears unnecessary. Labor regulations allow a satisfactory degree of wage flexibility through the use of incentive-based and collectively bargained bonuses, overtime wages, and miscellaneous discretionary allowances. 2.39 In the short term, therefore, the way to encourage wage flexibility is to leave unchanged the government's policies towards unions, bonuses, and overtime wages. In the medium, to long term, however, flexibility of wages will need to be encouraged if Malaysia is to achieve the objectives of maintaining a competitive edge in unit labor costs and for employment stability. But successful implementation requires sound industrial relations and a broad consensus on how productivity gains are shared. Institutions that help to synchronize macro (unit labor costs) and micro (profit sharing) considerations. The foundations for these institutions must be laid now, when both wages and profits are rising, and issues of relative shares are of secondary concern. 2.40 Nabi (1991) analyzes the experiences of Japan, South Korea, and Singapore with flexible wage systems. Table 2.7 below highlights the main features of the treatment of bonuses and the state of labor-management relations in these countries. The study cites evidence that bonuses in Japan and Korea fluctuate more with the firm's financial performance than with wages. In our terminology, this indicates that noncontractual bonuses are relatively more important. In Korea, there is some evidence that overtime payments make wages responsive to business cycles, but poor labor-management relations preclude using bonuses as a device for directly tying compensation to performance. Singapore's experience suggests that it is difficult to set and implement national guidelines on wage-setting mechanisms that are responsive to a rapidly changing - 50 - environment.L' Given the similarities in the perceived role of the government, and the state of labor-management relations, Japan's experience may be the most readily adapted to Malaysian circumstances over the long-term. (c) Labor Unions. Collective Bargaining and Legislated "Merit Increments" 2.41 In Figure 2.5, the component that appears most disconcerting is the "merit increment" in wages, payable only to non-executive workers. This increment is in fact based on increases in the cost of living during the previous three years. Production workers are "entitled" to receive wage increases equivalent to two-thirds of the rise in the cost of living. Arbitration courts more or less automatically support claims by unions for these increments, since it is argued that firms have to be coerced into sharing their large profits with workers. Arbitration courts have often awarded 100 percent or more of the increase if it is believed that the firm is "doing well". This may have the effect of ratcheting up wage costs, squeezing out true merit-based incentives, and slowing down productivity growth. 2.42 These increments have the effect of building in wage increases into the basic wage. Singapore experienced this problem in the late 1970s and early 1980s, in response to which the National Wages Council (NWC) set up the Subcommittee on Wage Reform. The subcommittee identified the following rigidities: First, high annual increments which were predetermined in collective agreements for 2-3 years, insufficient incorporation of firm and worker performance in implementing NWC guidelines on profit sharing; annual and merit increments becoming permanently built into the salary structure and could not be downwards adjusted when company performance deteriorated, and the annual wage supplement, which was originally a year-end bonus become frozen by law. The NWC altered its guidelines to remedy these shortcomings. 2.43 While Malaysia's labor policies are far less centralized than those of Singapore, the pattern seems to be similar, and a similar re-evaluation of legislated merit and annual increments is recommended. Legislated cost-sharing between the firm and workers is difficult to effectively implement, and may in fact result in downward rigidity of wages. To be effectively legislated, "merit increments" must be based on the current and prospective profitability of the firm, and the latter is increasingly difficult to determine with any accuracy in a competitive economy open to outside influences. Besides, the argument that firms will not voluntarily share the gains during prosperous times seems without basis: Malaysian firms seem to use bonuses to do so, and meet unpredicted increases in demand by liberally using overtime labor. W' There is little evidence that wage flexibility attained through bonuses results in higher employment. Given the difficulties in measuring productivity, there is also no clear evidence that such profit sharing leads to higher productivity, leading to conjectures that workers may dislike the variability in earnings associated with profit-sharing schemes. - 51 - (d) Recommendations 2.44 The first recommendation is that the treatment of bonuses and other performance increments in labor law and arbitration courts should be continued, but a parallel in-depth review of the role of collective bargaining in nonwage component increases is needed. In particular, this report recommends re- examining the role of unions in negotiating bonuses and "merit increments" in wages, along the lines of Singapore's April 1986 review by the NWC's Subcommittee on Wage Reform. Bonuses are currently being used as the main instrument of wage flexibility; in 1991, more than half of total bonuses paid were noncontractual, and so were presumably to reward employers for their or the firm's performance. But international experience indicates that there is a tendency for bonuses to become contractual where compensation is collectively determined. Japan's experience indicates that a truly flexible wage system in the presence of collective agreements can be instituted with in-house workers' unions. 2.45 The second recommendation is to design and implement appropriate legislation and economic incentives to strengthen in-house worker unionsW, that are likely to be more supportive of tying wages to performance and in promoting worker training. In the meantime, additional legislation that will rob the system of wage flexibility due to bonuses, overtime work provisions, and other nonwage incentives should be avoided. Table 2.6: Total Bonuses Paid, By Occupational Category an Survey of 86 Manufacturing Firms, 1992) Occupa*onaI Average Mazhmwa Amoun Category Months/Year Month/Year Ringgit/Year Managerial 1.77 4.5 5837.5 Technical 1.91 4.5 2072.5 Supervisory 1.75 4.3 2030.0 Clerical 1.68 4.0 1150.5 Skilled 1.56 3.4 1041.0 Unskilled 1.48 3.4 630.5 Note: Tbe average contractual bonus in the sample was 0.85 months per year, ranging from 0 to 2.5 months. Contactul bonuses generally do not apply for executive positions (managerial and technical workers). 22' In-house unions are preferred over trade or industry-wide unions in profit sharing wage-systems, since workers respond to firm specific productivity incentives rather than at the wider trade or sector level. Japan's success with in-house unions while implementing wage-flexibility is instructive. - 52 - FIRMS USING INCENTIVE SCHEMES, 1993 manuafctur Ing No& rnuf KturinoG Piro on ~ n¢tl qto 7' so so 40 20 Thr. f Sm~nal Tn-t0 ut I t I a utlv. Figure 2.5 - 53 - Table 2.7: Bonuses, Union Membership, and Labor-Management Relaions In Three High-Performing Asian Economies Japan Korea Sinppore Bonuses Frequency Twice each year Predetermined by Generally Annual Negotiation Share of Compensation 20 percent 10-15 percent* Share of Profits 42-76 percent Method of Negotiation Separately from Wages Collective agreements; National Wages Council Ratio of base wages guidelines Main purpose Wage-flexibility and work "Bribes" to attract incentives workers from other firms and to prevent dissonance Union Membership Enterprise-based 90 percent Industry-wide 10 percent Labor-Management Relations Generally good Generally poor Generally good Notes: * More recently. Korean firms have begun using productivity-based bonuses that range as high as 50-200 percent of wages. Sources: Nabi (1991) - 54 - ANNEX FIGURES AND TABLES NONWAGE COSTS AS A FRACTION OF WAGES W 3-Dlgrt UtnutctLrilng, 1U-1I91 3s2 311 3J~1 33115 143 J3 32j 3-dlf t cOM Co 00 + 1tSt o X Inc-v" Figur Al TURNOVER I N F IIRMS, JUNE '92 TO MAY '93 , "-kol I,t .,".*, . + sctkw_ Figure A - 55 - Table Al: Determinants of EPF Contrlbutions, 1961.1993 (Dependent Variable is Total EPP Contributions in RM Mifliom) Equation I Euation 2 Equaton 3 Mm Time 161.73 177.52* -205.90* 1977 (4.76) (5.08) (-6.27) Contribution Rates: 1. Employee (percent) 2361.38* 4406.20* 1711.85S 6.78 (4.86) (5.01) (4.35) a 2. Employer (percent) -2877.55* -2979.19* -1219.41* 7.75 (-4.44) (-4.67) (4.34) I Real Rate of Return 55.17 12.05 3.37 (1.49) (0.82) 4 Number of Contributors: 1539.40* 3.41 1. Employees (millions) (4.36) 3 2. Employers (mi1lions) 23372."* 0.09 (2.32) s R-Squared 0.882 .891 0.985 Sample Size 33 33 33 Notes: All regressions include a constant. * denotes significant at 5 percent level or smar. Sources: Al data is from Statistical Bulletin, 1992 (EPF). - 56 - Table A2: Determinants of Bonuses (Dependent Variable is Occupation's Noncontractual Bonus in Months) Union Foreign Firm Size Consr. Obs. Present Firm (J Employees) Managerial -0.445 -0.359 0.000 1.099* 79 (-1.50) (-1.28) (0.36) (2.13) Technical -0.164 0.958 -0.000 0.108 80 (-0.29) (1.83) (-0.42) (0.91) Supervisory -0.727* -0.238 0.000 1.279* 81 (-2.77) (-0.99) (0.39) (2.89) Clerical -0.573* -0.139 0.000 1.66* 86 (-2.78) (-0.71) (0.06) (3.23) Skilled -0.713* -0.159 0.000 1.000* 78 (-3.36) (-0.85) (0.14) (2.86) Unskilled -0.722* -0.069 -0.000 0.771* 85 (-3.89) (-0.39) (-0. 50) (2.38) Dependent Variable is Contractual Bonus in Months All Occupations 0.927* 0.023 -0.000 0.760* 86 (5.45) (0.15) (-0.90) (2.55) Note: All regression include industry dummies. * indicates significant at I percent level. Sample consists of 86 manufacturing firms; survey conducted in 1991. - 57 - Tabl A3: Propensty to Adopt Flei-Wage Sysem (Resuls of Probit Estimats) Dependent Variable is Answer (Yes- 1, No -0) to Qution: Will You Adopt a Plexi-Wage System? Variabe Equdon 1 Equwon 2 Jqotion 3 Union -0.779* -0.783* -0.587 (-2.12) (-2,12) (-1.50) Finn Size -0.001* -0.001' 0.001' (-2.59) (-2.56) (-3.14) Foreign Firm -0.040 -0.066 (-0.12) (-0-15) Unskilled Workers/ -3.338 -3.337 -3.610 Total Employment (-1.68) (-1.68) (-1.70) Skdlled Workersl -2.974 -2.981 -3.121 Total Employment (-1.51) (-1.51) (-1.44) Clerical Workers/ -8.758* -8.779* -10.5S7 Toul Employment (-2.22) (-2.22) (-2.50) Supervisory Workezs/ 6.450 6.393 8.751 Totl Employment (1.59) (1.S6) (1.95) Constant 3.881* 3.908* 3.903 (2.05) (2.05) (1.86) ndustry Dummies Not Included Not Included IwAcded Chi-Squared 18.61 18.63 25.24 Observations 81 81 81 ANote: * indicales sipificant at S percent level or lower. - 58 - III. AUGMNNTING THF LABOR FORCS: THE ROLZ OF INNIGRATION Introduction 3.1 Between 1987-93, Malaysia created 14 million jobs at the rate of 3.9 percent compared to domestic labor force growth rate of 3.1 percent. The gap has been filled by immigrant workers. It is now estimated that almost 1 in 6 workers employed in Malaysia is an immigrant, and immigrant workers generate about 1/8th of Malaysia's GDP. The Mid-Term Review of the Sixth Malaysian Plan issued in December 1993 states that *the use of foreign labor should not be regarded as a permanent solution to overcome the tight labor market situation.' (Economic Planning Unit. 1993, 52). The report described the share of foreign workers in the Malaysian labor force as 'already high,' and noted that the Malaysian government will encourage labor-saving production processes, promote labor mobility, and encourage women to join the workforce to avoid dependence on foreign workers. 3.2 The central issues examined in this chapter are: how to assure local and foreign investors that a workforce with the necessary skills will be available to fill the jobs created by their investments * how to manage migration in a manner that avoids being too strict, risking a wage spiral and reduced investment in Malaysia, and too open, risking the dependence of some sectors on continued reliance on immigrant workers. 3.3 Malaysia can benefit in dealing with these questions from the experiences of the traditional immigration counties, such as the United States, Canada, and Australia, from the experiences of reluctant lands of immigration in Western Europe, and from the experience of rotating guestworkers in Singapore. A. Immiaration: Stocks and Flows 3.4 The most widely cited estimate of the number of immigrant workers in Malaysia uses Malaysian Trade Union Congress (MTUC) assumptions about the share of foreign workers employed in four economic sectors. It concluded that there were 1.2 milliony' immigrant workers in Malaysia in 1991, i.e., immigrants were on average 17 percent of Malaysian employment in 1991, and 19 percent of the labor force employed in these 4 sectors (Pillai, 1992, p. 43). Almost half of these immigrant workers were believed to be in agriculture and forestry, followed by construction and services. V' Using the same data that appears in Pillai (1992), 43) there were in fact 1.1 million foreign workers in 1991. - 59 - 3.5 Most of the public and private sector people interviewed in March 1994 had neither an estimate of immigrant stocks and flows nor a proposed methodology to obtain such data. For this reason, it seemed most appropriate as a first step to apply 1991 immigrant shares to 1993 employment data. This procedure indicates that there were 1.2 million immigrant workers in the non-public sector in the country in 1993, suggesting that the number of foreign workers has been increasing by 17,000 per year. Table 3.1: Estimated Immigrant Workers in Malaysia by Sector In 1991 (non-publlc employment) Employment Immigrant Share Estimated Immigrant Distribution 1991 (000) Percent Workers (000) Agriculture and Forestry* 1,835 30 550.5 48% Construction 456 70 319.2 289% Manufacturing 1,374 3 41.2 4% Non-government Services 2,290 10 229.0 20% Total Employment 6,849 17 L,140 100% Source: Adapted from Pillai, 1992, 43. * There is general agreement that 30 percent of the plantation estate workers are immigranLt, but the share of immigrants ia total Malaysian agriculture and forestry employment is less clear. Navamukundan (n.d., 24, 32-3) asserts that one-third of 250,000 plantation workers are immigrants, suggesting 82,500 foreign workers. There are additional immigrant workers in smallholder agriculture, such as Thais who work seasonally in northern Malaysian rice farms, and in forestry, but there appear to be no data to suggest that they number 550,000 - 82,000 - 468,000. This means that the number of foreign workers in agriculture obtained by assuming that 30 percent of al those employed in agriculture and forestry may be an overestimate. 3.'6 This procedure makes non-public employment growth the sole determinant of the estimated number of foreign workers. For example, the projected decrease of 76,000 immigrant workers in agriculture between 1991 and 1993 reflects decreased employment there, and the 66,000 increase in immigrant construction workers reflects increased employment there. Foreign workers share analysis suggests that foreign workers will be a declining share of Malaysia's workforce, since employment growth is projected to be fastest in manufacturing and services, sectors with relatively few immigrant workers. 3.7 Since there was considerable uncertainty about immigrant shares of employment by sector, it seemed appropriate to generate high and low scenarios by halving and doubling them. If the immigrant share of the labor force in these 4 sectors was only half of the 1991 estimates, then the number of immigrant workers in 1993 would have been 587,000. Alternatively, if the immigrant share were 50 percent larger (100 percent of those employed in construction), the number of immigrant workers would have been 1.7 million. 3.8 Share analysis suggests that immigrants might be 8 to 23 percent of Malaysia's non-public employment. The medium scenario indicates that immigrants were 16 percent of the 7.4 million employed workers in Malaysia in 1993, and that immigrant worker employment increased at a slower rate (3 percent) than did total employment (18 percent) between 1991 and 1993. - 60 - Table 3.2: Estimated Immigrant Workers In Malaysia by Sector In 1993 Employment Immiugrant Share Estimated mmigran Numerical Change Percentage Change 1993 (000) Percent Workers (000) 1993-1991 1991-1993 Medlum Scenado Sector Agriculture and Forestry 1,580 30 474.0 -76.5 -14% Construction 550 70 385.0 65.8 21% Manufacturing 1,766 3 53.0 11.8 29% Non-goverrnentServices 2,617 10 261.7 32.7 14% Total Employment 7,411 16 1,174 33.8 3% Low Scepnaro Sector Agriculture and Forestry 1580 15 237.0 -313.5 -57% Construction 550 35 192.5 -126.7 -40% Manufacturing 1760 1.5 26.5 -14.7 -36% Non-government Services 2617 5 130.9 -98.2 -43% Total Employment 7,411 8 587 -553.1 -49% HikUMMcep Scctor Agriculture and Forestry 1580 45 711.0 160.5 29% Construction 550 100 550.0 230.8 72% Manufacturing 1766 4.5 79.5 38.3 93% Non-governmentServices 2617 15 392.6 163.6 71% Total Employment 7,411 23 1,733 593.1 52% Source: Immigrant shares are from Pillai, 1992, 43; Employment data re from EPU Mid-Term Review, 1993, 38 Medium scenario assumes that the percentage of immigrant workers by sector in 1993 is the same as estimated for 1991. Low (high) scenario assumes that the percentage of immigrant workers by sector in 1993 is half (1.5 times) the percentage estimated for 1991. 3.9 There are several ways to consider the relationship between foreign worker employment growth and the increase in total employment. According to the medium immigrant share scenario, foreign worker employment increased 3 percent between 1991 and 1993, while total employment rose 8 percent. Alternatively, 6 percent of the 562,000 net new jobs in Malaysia between 1991 and 1993 were filled by foreign workers. 3.10 The demand for foreign workers seems to be declining. But immigrant workers are not of declining importance in the Malaysian economy for three reasons: * First, manufacturing and service employers are complaining of labor shortages and requesting permission to employ immigrant workers. If the manufacturing workforce were to have a 16 percent foreign worker share by 1995, there would be an additional 320,000 immigrant workers in that sector alone. * Second, the traditional immigrant ports of entry-agriculture and construction-are revolving door labor markets, in the sense that immigrants enter these sectors from abroad and then move into the informal economy of street hawking and service jobs. So long as these sectors remain dependent on immigrant workers, some of whom move into the informal economy, the number of immigrants will grow faster than foreign worker employment by sector. - 61 - * Third, the Malaysian government has announced ambitious development projects in Sabah, which is believed to have over 40 percent of all Malaysia's foreign workers. Development there may draw additional immigrant workers to east Malaysia.> 3.11 The number of immigrants in Malaysia may also increase if foreign workers marry Malaysians or unite their families in the country. In Europe, the number of spouses and dependents, plus second and third generation foreigners born or raised in the country recruiting foreign workers, typically surpassed the foreign workforce with two decades after the entry of the first foreign workers (Martin, 1994). Other Immiczrant Data 3.12 The Immigration Department has no estimates of the number or distribution of immigrant workers .3' The Department reported that 447,000 illegal aliens 'registered" between November 1, 1991 and June 30, 1992, meaning that they got temporary passes and, after medical examinations and payment of the foreign worker levy, they were eligible for 2-year work permits. However, only 190,000 of them obtained such work permits by December 31, 1993. Between July 1992 and December 1993, a total 54,155 aliens were apprehended. About half were released after being offered jobs by Malaysian employers, and 4866 illegal aliens were reportedly being held in 8 detention centers in February 1994. 3.13 The only regularly published data on immigrant workers are in the establishment survey. The survey divides immigrant employees into two groups: workers hired directly by the employer, and workers hired indirectly through labor contractors. It is widely conceded that the number of foreign employees in the establishment survey is underreported, both because employers misclassify directly-hired foreigners as Malaysians, and because they understate and misclassify the foreigners brought to their worksites by labor contractors (LCs). 3.14 There are also non-governmental surveys that obtain data on foreign workers. Both Azizah and Hugo, for example, report data on surveys of immigrant ' The state governments of Sabah and Sarawak were given control over immigration in 1963 to prevent peninsular Malaysians from moving there and depriving natives of economic opportunities. The National Front Coalition which came to power in March 1994 has promised to remove controls on travel between peninsular Malaysia and Sabah. 31 There are a number of press and other speculative estimates. For example, an April 15, 1994 press account reported that Malaysia "officially" estimates that it has "nearly half a million" foreign workers, while NGOs "say the real figure is close to 2.5 million." (Interpress Service) . The U.S. Embassy's economic report on Malaysia in 1994 put the number of foreign workers at 2 million of the country's 7 million workforce, and reported that 1 million of the foreigners were illegal aliens (Reuter Asia-Pacific Business Report, January 22, 1994). - 62 - workers in Malaysia, but there have not yet been enough such surveys carried out to determine the generalizability of their findings. Much of the data on migrant characteristics seems to be derived from anecdotal press accounts. The following table, for example, includes two references to academic-style studies of the differences in earnings for foreign workers in their country of origin and in Malaysia, and 8 journalistic accounts. It makes the point that wages in Malaysia are 3 to 10 times higher than in Indonesia. Table 3.3: Some Wage Differentials Between Indonesia and Malaysia Year Source Area Wage in Source Wage in Destination Diference Source 1990 Lombok Rp50>-1000 per Rp7-8000 per day (oil 800 percent Vatikiotis, 1990 day p/a/m) 1989 Indonesia SS70-100 per SS500-700 per month 500 percent 300 Guinnes, 1990 month (Singapore) S$300 per percent month (Malaysian) 1988 Indonesia Rpl50-250,000 per month Kompas, 9 August 1988 1991 Indonesia M$2.15 per day M$12.50 per day 580 percent Dorall and Paranmasivam, (Females) 1992 1992 Indonesia Rp3000,000 per month Jakarta Post, 9 October (Bruneiminimum wage) 1984 East Java Rp3000 per day Rp9000 per day 300 percent Termpo, 7 April 1984 1982 Tanjung Pinang Rpl500 per day Rp700 per day 467 percent Tempo, 27 February 1982 1982 Bawean Rp500 per day Rp9000 per day 1800 percent Tempo, 27 February 1982 1990 Indonesia Rpl ,000 per day RplO,000 per day 1000 percent Straits Times, 7 December 1990 1991 Semarang Rp25000 per day RplO,800 per day 432 percent Suara Karga, 6 November (Sarawak) 1991 Source: Hugo, 1993, 26. 3.15 Malaysia needs better data on immigrant stocks and flows. Such data could be obtained by modifying the establishment surveys currently used to obtain data on employment and earnings, perhaps by conducting a separate survey of workers hired through labor agents or contractors. Useful data could also be obtained by surveying some of the aliens apprehended to determine how they reached Malaysia, what they earned at home and what they expected to earn in Malaysia, and what kinds of penalties they feared most. Finally, employers where illegal workers were apprehended and those who employ illegal workers but whose places of employment have not been inspected could be surveyed to determine why foreign workers were hired. Future Immigration 3.16 Malaysia is not a declared country of immigration; the government does not anticipate an annual influx of immigrants. However, Malaysia does welcome business and tourist visitors, and has programs under which non-immigrants can work temporarily in the country. It is generally believed that the number of illegal migrants in the country exceeds the number legally present. 3.17 There need be little concern about the future supply of immigrants willing to work in Malaysia. Malaysia is akin to a small island in a sea of - 63 - potential foreign workers. Indeed, what distinguishes Malaysia from Western European and North American nations that are grappling with illegal immigration is the fact that only Malaysia is dwarfed in size by the countries from which most foreign workers come. The United States, for example, is almost three times more populous than Mexico, France is larger than Algeria and Morocco, and Germany larger than Turkey and the former Yugoslavia, but Indonesia has almost ten times more people than Malaysia, Bangladesh six times, and the Philippines and Thailand three times. 3.18 Rapid economic growth in Thailand may reduce the availability of migrant workers from that country,- but it is unlikely that job growth will be fast enough to reduce incentives to migrate from Indonesia, Bangladesh, and the Philippines for jobs in Malaysia. If even more foreign workers were needed, Vietnam, China, and India and Pakistan could provide enough workers to meet any conceivable labor shortfalls in Malaysia. B. Benefits and Costs of Immigrant Workers 3.19 In virtually all countries with foreign workers, employers request them, unions oppose the importation of migrant workers, and the government acts as referee. In the US and Western Europe, governments have established programs that admit foreign workers after employers convince the Labor Department that they suffer from labor shortages that are best filled with foreign workers. union opposition is often pro forma, since most foreign workers are imported when the economy is booming and unemployment is low, and most foreigners are employed at the bottom of the labor market, where there is rarely competition with union members. 3.20 Managing labor migration has proven to be a difficult challenge for governments. In Western Europe, most foreign workers returned to their countries of citizenship as planned, but enough settled that controlling immigration has become a major socio-political issue from the UK to Italy. In the US, illegal immigrants accompanied legal guestworkers, and an amnesty for some of them has increased the number of immigrants enough that, according to opinion polls, over 60 percent of Americans want legal and illegal immigration reduced. 3.21 The short-term effects of foreign workers are generally seen to be positive, while their longer-term effects are usually perceived to be mixed, a point made by Kindleberger in 1967: 'the short-run economic benefits ... are positive, although there are social costs. In the intermediate and long run, the economic advantages become less clear... to rely heavily on foreign labor constitutes a positive risk... 30 percent is too high. 10 perCent seems acceptable.. .To locate the discontinuities more precisely is probably impossible.' (1967, 213). ' Thai workers migrate to northern Malaysia seasonally to work in the rice and sugar harvests. There is apparently little data on this seasonal worker program; Malaysian employers of seasonal workers, however, reportedly do not have to pay the foreign worker levy - 64 - 3.22 There is relatively little analysis of the effects of foreign workers on the Malaysian economy and society. Instead, there are several assertions made about the economic impacts of immigrant workers. Their benefits may include: * immigrant workers expand Malaysia's GDP and relieve labor shortages * immigrant workers can serve as counter cyclical economic policy instruments, imported to prevent wage inflation during boom times and returned home when unemployment rises * immigrants can raise productivity by expanding the market in a manner that allows for economies of scale. The costs associated with immigrant workers may include: * their availability may depress wages and increase unemployment, especially if employers prefer immigrants because they work "hard and scared" * the availability of immigrants may slow the development and diffusion of labor-saving production processes, making Malaysian industries competitive on the basis of low wages rather than high productivity * migrants may be using social services without paying for them. Inadequate data makes it hard to answer these assertions definitively, but the data available suggests that there is little evidence of significant costs. Macro Effects 3.23 If immigrant workers are paid the same wages as Malaysian workers, and if the immigrant workers are as productive as Malaysian workers in the sectors in which they are employed, then immigrants contributed about 12 percent to Malaysia's M$100 billion GDP in 1993. The immigrant GDP contribution is lower than their employment share because immigrants are concentrated in lower-paid sectors. Table 3.4: Estimated Immigrant Contribution to GDP: 1993 1993 GDP-MS mils 1978 Immigrant Employ Share Immigrant GDP Conmflbution prices Agriculture and Forestry 15,985 30 4,796 Construction 4,013 70 2,809 Manufacturing 30,216 3 906 Non-government Services 34,389 10 3,439 Total 100,475 11,950 Source: EPU, 1993. 28. - 65 - 3.24 Furthermore, if the immigrant workers earned an average M$300 monthly or M$3600 annually, then 1.2 million foreign workers would earn M$4.3 billion annually. Studies of migrant workers suggest that they spend an average 2/3 of their earnings in the country in which they are temporarily employed; if true in Malaysia's case, this would suggest that about 3 percent of Malaysia's GDP depends directly to migrant worker spending, and perhaps as much as 6 to 10 percent when the multiplier effects of migrant expenditures in Malaysia are considered. 3.25 Migrant workers also remit savings to their countries of origin. If the foreign workers in Malaysia remit 1/3 of their earnings, they would be sending about M$1.4 billion out of the country every year, or over MS100 million monthly.' Pillai (1992, 18) arrived at a similar estimate of remittances, and he considered negatively this 'significant capital outflow. However, remittances from migrant workers in Malaysia may also increase trade between Malaysia and their countries of origin, as migrants and their families buy Malaysian-made goods with which they became familiar because of employment there. Sector Effects 3.26 The leading students of Malaysian migration tend to emphasize its costs rather than its benefits, and they base their arguments on what they perceive to be the negative effects of migrants on what happened in particular sectors. Mehmet, for example, argued that tolerating an influx of unskilled immigrants to work on plantations contradicted one of the major goals of the NEP: the elimination of rural poverty. According to Mehmet 'reliance on imported cheap labor_.tends to reproduce poverty, contrary to NEP objectives" (1988, p. 26). Pillai seems to agree. He concluded that: (1) immigrants displaced Malaysians and depressed wages in agriculture and construction; (2) relying on migrants to attract Direct Foreign Investment was a false hope because Malaysia cannot hope to compete with Indonesia, Thailand and the Philippines for DFI that requires large numbers of unskilled workers; and (3) 'the availability of low-cost foreign labor' may impede the restructuring of the Malaysian economy and labor market (1992, p. 18-19). 3.27 Until December 1991, there were relatively few non-Malaysians employed in manufacturing; of the 21,162 non-Malaysian workers only 2 percent of the wage and salary workers were employed in manufacturing. Over half of these non-Malaysian workers were employed in just one of the 12 manufacturing ' According to some estimates, worker remittances to Indonesia alone were M$2 billion in 1991, although no basis for this figure was given (Financial Times, July 1, 1992, 6). In December 1992, the then Deputy Prime Minister Ghafar Baba stated that foreign workers send M$3 to 4 billion out of the country in remittances annually (Xinhua News Agency, December 24, 1992). A 1992 World Bank Discussion paper reported that remittances from Malaysia in the late 1980a were less than $200 million annually(Russell and Teitelbaum, 1992, 75 and 79). - 66 - subsectors: in wood and cork manufacturing (excluding furniture), almost 12,000 of 85,000 employees were non-Malaysians. (Employment of non-Malaysians increased in 1992-93 but sectoral breakdown is not yet available). 3.28 The presence of immigrant workers in wood and cork manufacturing (where 14 percent of the workforce is non-Malaysian) has had few adverse effects on wages or productivity. Average annual earnings during the 1980s evolved very similarly in wood and cork manufacturing and all manufacturing--average annual earnings in wood and cork manufacturing were 2 percent lower than the average for all manufacturing in 1981, and 11 percent lower in 1990, while the share of foreign workers in this industry's workforce almost doubled. Table 3.5: Malaysian and Non-Malaysian Workers in Manufacturing: 1981-1991 Malaysian Citizen Non-Malaysian Citizen Immigrant Percentage 1981 486,493 5,664 1% 1982 514,536 6,378 1% 1983 486,657 6,501 1% 1984 491,173 7,779 2% 1985 468,606 7,649 2% 1986 471,718 7,202 2% 1987 509,727 8,038 2% 1988 588,327 10,251 2% 1989 686,215 11,845 2% 1990 828,060 16,669 2% 1991 955,775 21,162 2% Source: DOS Establishment Survey. - 67 - Figure 1 Aveage Annml Earninghfr AUMfg and Wood aud CorkWorkers: 191-1990 8000 7000 6000 > 5000 4 3000 X 3000. - -All Mir 2000 --O--- Vood a CorkI 100 o , . , | ~~~~~~~C. .h . 0 -O NO Co 00 Lo CO Cl OC co OD co eo co co co co _a Figure 2. Unit Labor Costs and Capitol-Labor Ratios for All Manufacturing and Wood and Cork, 1981=100 --*--- All Mrg-ULC -0--- All Mfg-KAL 250 . Wood and Cork-ULC 200 - - -- Wood and Cork-Ki 150 100 50 co 00 a coi > f > fi ff Unit labor costs are wages and saaries divided by the gross value of outpug K/L s the value of fixod assets divided by end of year employmenL - 68 - 3.29 Unit labor costs and capital-labor ratios also evolved similarly in the economy; nearly 1 in 7 workers was a non-Malaysian and in all of manufacturing, 2 in 100 workers was non-Malaysian. Unit labor costs fell faster in wood and cork sub-sectors than in all manufacturing. The capital-labor ratio rose in wood and cork sub-sectors, but slower than in all manufacturing. 3.30 The picture changes slightly if 1987 is used as the base year. In 1991, the value of fixed assets per manufacturing worker was about M$42,000, and about M$20,000 in wood and cork manufacturing. In 1981, the K/L ratio in wood and cork manufacturing was about 3/4 of the level of all manufacturing, then slipped to less than 40 percent of the all manufacturing level in 1987-88, and has climbed to almost 50 percent in 1990. 3.31 Other sectors of the economy (where DOS's establishment surges allow the breakdown of the total labor force into Malaysian and non- Malaysian workers) are also affected by the presence of immigrant workers. The evidence is that there were 4007 non-Malaysian workers employed in service industries that ranged from shipping companies to travel agencies in December 1991, but most were employed by shipping companies(40 percent) or in road haulage(23 percent) . In these industries data are available only between 1987 and 1991, but there are few differences in the evolution of annual average earnings in sectors more and less dependent on foreign workers. Sectors more and less dependent on non-Malaysians did not change their place in wage ranking. 3.32 Both unit labor costs and capital-labor ratios were remarkably stable in the Malaysian service sector between 1987 and 1991--wages and salaries were about 15 percent of the gross value of output, and the value of fixed assets per worker remained steady at about M$57,000. The two sectors that employ almost 2/3 of the non-Malaysian workers in services are at opposite ends of the spectrum of K/L ratios. Shipping--which accounts for about 45 percent of all the fixed assets in the Malaysian service sector--has a high K/L ratio that is 7 times the average, and road haulage has a K/L ratio that is 1/5 the average. However, while shipping unit labor costs and capital-labor ratios evolved along with the rest of the service sector, road haulage had slightly faster falling unit labor costs, and a significant jump in the K/L ratio in 1991. - 69 - Figure 3. Unit Labor Costs and Capitol-Labor Ration for All Manufacturing and Wood and Cork, 1987-100 -1-- All Mfg-ULC - °--~ AD Mfg- K Wood and Cork-ULC 140 T0- Wood ad Cork-KA, 100 = 0. 80 20 o* A0 r f o 8 > 0g 8 Unit labor costs are wages and salaries divided by the gross value of output K/L is the value of fixed assets divided by end of year employmenL Piue 4. Avrage AnanmIEamxtw inpe3d SvKes 1987-1991 Rosa HAuia -*- Servies 14'000 T . . . 12000 10000 -1. 6000 P4 2 4000 2000 0- II 1987 1988 1989 1990 1991 govrce: Dtpartmeat of Statistics Estalisha.at Ovny - 70 - Figure 5. Unit Labor Costs and Capitol-Labor Ratios for Road Haulage and All Services, 1987=100 ' ULC-Road *-~<>~~ K/L-Road ULC-Services 2.00 -0-- K/I-Scrvices 1.00t 0.00 1987 1988 1989 1990 1991 Unit labor cosu are wages and salaries divided by the gross value of output; KJL is the value of fixed assets divided by end of yea employmenL Public Finance Effects 3.33 It is sometimes asserted that migrant workers make use of Malaysian infrastructure and public services without paying for them. The calculation of taxes paid and the costs of providing services to immigrants is rife with controversy, but three points are often overlooked: * First, most migrant workers are young men eager to work, who in all countries make relatively few claims on social services. Since these migrant workers received free public education in their home countries, it could be argued that the immigration country gets a windfall by their presence. * Second, migrant workers do pay taxes when they purchase goods and services and user fees when they use public services. Most have relatively low earnings, so that, even if they were required to participate in the income tax system on the same basis as natives, they would pay relatively low taxes. If migrant workers do not pay sufficient user fees for the public services they consume, the solution is to raise user fees for all consumers. * Third, most industrial countries require legal and illegal migrant workers to pay income, employment, and social security taxes, even if they are not or will not be eligible for benefits under these programs. Malaysia currently exempts non-Malaysian workers from most of these programs, and this provides employers with an incentive to employ immigrants workers. An earnings-based levy could remove this incentive to hire immigrants and generate funds to deal with labor shortage issues. - 71 - Suecial Cases: Agriculture and Construction 3.34 Malaysia imported immigrants in the 19th century to develop its plantation and mining sectors. Since both plantations and mines offer year-round jobs, permanent immigrants were encouraged to move to Malaysia. Many of the immigrants from South India, South China, and to a lessor extent Java were indentured servants, who promised to work for several years for the Malaysian employer who paid their transportation. 3.35 Malaysia became independent in 1957, and the 1968 Employment Restrictions Act required Malaysian employers to obtain work permits for the non-citizen workers they employed. This resulted in the removal from the country of a 'large number" of Indian and Chinese workers (Nayagam, 1992, 478) . Their departure had few labor market impacts because Malaysia at the time had a fast growing labor force. 3.36 Plantation owners began to complain of labor shortages in the 1970s. Rural "labor shortages' were in part a consequence of NEP policies that encouraged rural-urban migration to better-paying factory jobs; many young people migrated rather than following their parents into rubber and palm oil weeding and harvesting. 3.37 Since 1978, the United Planting Association of Malaysia (UPAM) has conducted periodic labor shortage surveys, and they found that one-third to two-thirds of the responding plantations reported that they required 5 to 10 percent more workers (Pillai, 1992, 42 and Rahman interview, March 24, 1994). The Rubber Research Institute of Malaysia (RRIM) conducted similar employer surveys, and it found that plantations reported vacancies equivalent to 2 to 8 percent of current employment. Both RRIM and UPAM surveys indicate that the plantation labor shortage worsened in the 1980s; the RRIM surveys reported that the labor shortage was less during the mid 1980s recession; the UPAM survey suggests that high unemployment did not curb the shortage. Figwe 6. Empbk -R-ptirtd Pbltatz Labow amtmspMaeh3f: 190-1991 14 12 O~ ~ O UA 4, 1980 1982 1984 1986 1988 1991 Novoce: Hayapa,1993,10. The peteatop iste slottafUof wovkersas a shrer.eo( w teabyueaso the iil 1991, UPAMiV ealoyers epiottel the they ve e shott about 11,600 workers (11.6 pe rea at of 100,0O). - 72 - 3.38 Plantation employers since the 1970s have maintained that the wages and conditions they offer should be sufficient to attract Malaysian workers, but plantation jobs remain vacant because they are not desired by youth in a country that has announced a goal of industrializing, and also offers educational opportunities for young people. Furthermore, plantations should not be allowed to shrink for lack of labor, they argue, because agriculture can earn foreign exchange for Malaysia with only imported labor.F The National Union of Plantation Workers (NUPW), with 61,000 members,7' largely agrees that plantation agriculture's contribution to Malaysia's economy is not fully appreciated. 3.39 The two extreme options to deal with plantation labor shortages are to deregulate the plantation labor market and open up the sector to legal foreign workers, versus retain current regulations and upgrade social services to make plantation jobs more attractive to Malaysian workers. It is clear that there are incentives to hire single male foreign workers through labor contractors--they do not have to be housed at plantation expense, and there is no need to make EPF contributions on their behalf, thus saving employers the cost of fringe benefits. According to Nayagam, employers prefer immigrants because they work more hours per month and are more reliable workers(1992, p. 484);!' these labor savings more than offset the M$360 annual levy on each foreign worker imposed in 1992,1' plus additional processing and medical examination fees of M$150. 3.40 A new system that involves government, employer, and union representatives should be established to deal with foreign workers in the plantation sector. This system would be financed by a levy based on the earnings of legal foreign workers, and it would allow those closest to the labor problem to work out a Malaysian solution to the plantation labor dilemma. W Plantation representatives observe that much of Malaysia's manufacturing economy has a maquiladora flavor, with little local value-added except for labor. In 1993, electronic goods were 40 percent of Malaysia's total exports. 1/ According to the US Department of Labor's Foreign Labor Trends: Malaysia(93-37, 17), the NUPW is Malaysia's largest union, with 61,423 members in 1992. This represents a sharp drop from 77,653 in 1991 and from 115,746 in 1980. V According to UPAM, the typical estate must employ 4 to 5 percent too many workers so that someone can go to work when Malaysian employees do report for work. Foreign workers, by contrast, reportedly are eager to work long hours 7 days a week. ' The levy on foreign plantation workers was reduced to M$300 in April 1993. - 73 - 3.41 The system could work as follows. If there are 500,000 foreign workers employed on Malaysian plantations and in forestry today, and they earn an average M$3600 annually, a 12 percent levy--equivalent to what employers do not pay in EPF contributions--would raise M$216 million annually. If such a fund were available, it is likely that monies would be spent (1) by the government to process foreign workers and enforce labor laws, (2) by employers to search for labor-saving innovations and (3) by unions to upgrade the quality of life on plantations. Construction 3.42 The construction industry appears to have the highest percentage of immigrants in its workforce . Pillai estimated that 70 percent of the country's 335,000 construction workers in 1991 were immigrants, while press accounts quote the MHR as saying that 45 percent of construction workers are foreigners (Los Angeles Times, December 6, 1993, D3). The establishment survey tells a different story-it reports that only 15 percent of the construction industry workforce throughout the 1980s were non-Malaysians. P1ge 7. PaM Warhers l!mplod In Cmstucdm at the Eind of the Year: 1981-1991 350000 T 300000 250000 _--"t- 200000 150000 - Ma]ysiaas 100000 O Noh-?hayi.AWs 50000 - N X r0' r o c O Co Co _ n cr o 0 0W0 3.43 The Malaysian construction industry found it hard to attract local workers during the building boom of the late 1970s and early 1980s. To overcome the labor shortage, immigrant workers-who were paid lower wages-were hired, and a three tiered wage system evolved in which immigrants earned M$14-16 per day, Malays M$20-25, and Malaysian Chinese M$25-35 (Pillai, 1992, p. 10). Immigrant workers were substituted for Malaysians so fast during the 1980s that, by 1987, some 60 percent of the 300,000 to 350,000 construction workers were immigrants. - 74 - 3.44 After the immigrant network was established in the late 1970s and early 1980s, it became progressively easier for immigrant workers already employed on, e.g., estates, to abandon farm jobs for construction jobs, or to enter Malaysia and go directly to a construction job. At the same time, construction booms in Taiwan and Japan attracted some experienced Malaysian construction workers to migrate to these countries for higher wages. 3.45 In 1991, the establishment survey reported that there were 363,000 construction employees, including 52,000 non-Malaysians. Two-thirds of the non-Malaysians were hired through labor contractors. A 12 percent earnings-based levy on average annual earnings of M$5000 would raise M$600 per foreign worker. If there are 52,000 foreign construction workers, an earnings-based levy would raise M$31 million annually; if there are 385,000 foreign construction workers, as employment share analysis suggests, M$231 million would be raised. In either case, an earnings-based levy that was administered by employer, union, and government representatives would have funds to improve the administration and enforcement of the foreign worker program; levy funds might also be used to re-attract to Malaysia some of the more skilled construction workers who have left for Taiwan, and to establish technical schools to teach construction skills. C. Immigration Policies 3.46 Malaysian immigration policies aim to control the employment of foreign workers by: * border and interior enforcement to prevent the entry and employment of illegal aliens i providing a mechanism whereby Malaysian employers can employ foreign workers legally if there are shortages of Malaysian employees * :.nfluencing foreign worker employment by deciding which sectors can employ each type of worker and charging a per worker levy 3.47 Malaysia began to regulate immigration when it achieved independence in 1957. There was relatively little attention paid to immigration or emigration until 1968, when the 1968 Employment Restrictions Act required Malaysia employers to get work permits to lawfully employ non-citizen workers. Sabah and Sarawak retained control over immigration when they joined Malaysia in 1963. Foreign Worker Proarams 3.48 In 1984, the Malaysian government signed the Medan agreement with Indonesia, and this agreement, under which Malaysian plantations could recruit immigrant workers if there were no Malaysian workers available, was soon extended to the Philippines, Thailand, Bangladesh, India, and Pakistan. Only agricultural employers could legally recruit foreign workers, and then - 75 - only after the local employment office agreed that Malaysian workers - unavailable. The process for legally obtaining foreign workers was considered cumbersome, and there was little enforcement, so that illegal immigration continued. 3.49 On January 4, 1989, the Malaysian government launched a program to regularize foreign workers employed in agriculture by requiring the Indonesians among them to be taken to the port city of Malacca and then returned to Sumatra. There they were issued work permits, and then returned legally to Malaysia-this 'drying out the illegals' process took one week and cost $M300 per worker, and was thus avoided where possible by both alien workers and Malaysian employers, so that fewer than one-third of the estimated 550,000 illegal alien farmworkers were legalized (Azizah, 1991, 23). 3.50 Relatively few workers were legalized or brought into Malaysia under the 1989 program because the process was too slow and expensive. As the following table indicates, there were at least 12 steps involved in the 2 to 6 month wait between an employer request and the arrival of foreign workers. - 76 - Table 3.6: The Process for Recruiting Lepl Forelgn Pntation Workers (Pre-1992) 1. An employer approaches a local agent (LA) with a request for foreign workers for the agricultural sector. 2. The LA writes to the Immigration Department (1D), requesting permission to import foreign farm workers. 3. lhe ID writes to the Ministry of Human Resources (MHR), requesting verification that the type of labor required by the employer is not available in Malaysia. 4. The MHR writes to the ID, verifying the need for such workers in Malaysia. S. The ID gives permission to the LA to recruit foreign workers. 6. The LA then informs his contacts overseas (CO), who recruit workers. 7. The CO recruits foreign workers, and sends their names to the LA in Malaysia. B. The LA sends the list of foreign workers to the ID. to provide them to the police for screening. 9. The list of names is then discussed at a meeting of the Jawatankuasa Pengambilan Pekera Asing (JPPA) or Committee for the Recruitment of Foreign Labor under the Ministry of Home Affairs. 10. If the JPPA approves the list, the ID issues work permits to the LA. 11. The LA then aks the CO to get the necessary travel documents for the workers and to send them to Malaysia by air or by boat. 12. When the foreign workers arrive in Malaysia, the LA tansports the workers to the prospective employers. Note: The time between the initial employer request to the arrival of the foreign workers is usually 2 to 6 months. Source: Adapted from Pillai, 1992, 50. 3.S1 On October 16, 1991, the Malaysian government revised its immigration policies. The new policy, to be effective for 5 years, required all foreign workers to have a legal status and to receive the same wages and benefits as Malaysian workers. A three-step procedure for determining whether Malaysian employers truly needed foreign workers, and for regulating their entry and employment, was established: * labor-short employers first contact the Ministry of Human Resources (MHR) to determine if unemployed Malaysian workers are available and, if local workers are not available, they can have their need for foreign workers certified, * an employer certified to import foreign workers provides a aregistered agent or broker with the details of the foreign workers needed, and the agent in turn arranges with the Immigration Department to have a Malaysian consul abroad issue entry and work documents to foreign workers, * the foreign workers undergo a medical screening and are - 77 - brought to the Malaysian worksite on 1 or 2 year temporary work visas, and they or their employers pay an annual levy (from M$360 to M$2400 per worker per year, but M$420 per worker in most cases). 3.52 The October 1991 policy change also included Malaysia's third amnesty or registration program for illegal alien workers since 1984. Unlike amnesties in Europe and the United States, which grant legal immigrant status and the right to eventual citizenship to illegal aliens who met certain criteria, the Malaysian registration program initially permitted illegal aliens employed in the plantation and construction sectors to register with Immigration authorities between November 1 and December 31, 1991 and, after a medical exam and the levy was paid, they could obtain 2-year legal work permits.'2' Registration was encouraged by the threat of stepped-up enforcement after the end of the registration period. Relatively few illegal aliens registered during the last two months of 1991,L' and employers, fearing labor shortages, persuaded the government to extend the registration periodLV-and defer stepped-up enforcement-until June 30, 1992. ' Permanent immigrants--those with red identity cards--had the restrictions on where they could wok lifted in October 1991. -Wi Employers complained that illegal Indonesian workers who registered had to be taken to Melacca, undergo medical examinations, be taken the 24 miles across the Strait of Melacca to be issued an Indonesian passport and a Malaysian work permit, and then, after the levy was paid, the now legal worker was returned to the plantation or construction site. The costs of this were estimated at M$ 500 per worker, plus 2 to 3 weeks of lost employment. l' Extending the registration period allegedly encouraged additional illegal aliens to enter Malaysia--there were numerous press accounts of aliens who paid smugglers to get them into the country, leading in some cases to tragedy and abandonment(Pillai, 1992, 31). - 78 - 3.53 By the time the registration period ended on June 30, 1992 and some 447,000 illegal aliens-equivalent to 6 percent of Malaysian employment-had registered.i Indonesians dominated the illegal aliens who came forward; they accounted for 83 percent of all those who registered, and 5 countries accounted for 99 percent. Figure 8. Illegal Aliens who Registered in Malaysia between December 1, 1991 and June 30, 1992 90% 709'o 60% 50%. 40%.. 30% 2D% 109. 0% Indonesia TliaiJand Bangladesh Burma (Myn mar) India Countries with 2 percent or morc of 400,552 registrants 3.54 Immigration authorities began a well-publicized operation to arrest the estimated 100,000 remaining illegal aliens"' in Peninsula Malaysia, including spending M$10 million to build 9 detention centers to ' Most of those who registered and got temporary passes did so in the last month of the registration period. In mid-May 1992, there were 19,900 maids, 21,600 plantation workers, and 65,100 construction workers registered(The Straits Times, May 11, 1992, 19) . By mid-June, there were 206,300, 80 percent Indonesian(Xinhua News Agency, June 25, 1992, and by the end of June, 320,000 illegal aliens had taken the first registration step. In September 1992, the final tally was 447,000 illegal aliens who had registered(The Straits Times, October 27, 1992, 19). There were apparently no studies of the characteristics and earnings of these illegal aliens who registered, although the mandatory health screening produced reports that e.g. one-fourth of those who had medical examinations had diseases ranging from malaria and venereal disease to leprosy and the human immunodeficiency virus (HIV). Malaysia deports foreigners with these diseases(Japan Economic Newswire, December 22, 1992). BY During the first week of July 1992, some lB00 aliens, 3/4 Indonesians, were detained. - 79 - hold the aliens arrested (Pillai, 1992, 31). Between July 1, 1992 and October 31, 1993, about 52,000 illegal aliens were detained; 70 percent were Indonesians, and 15 percent Bangladeshis. However, fewer than half of those detained during this period were deported. Table 3.7: Illegal Aliens Apprehended in Xalaysia between July 1, 1992 and October 31, 1993 Country Illegal Aliens Indonesia 70% Bangladesh 15% Thailand 6% Burma (Myanmar) 4k India 2% Pakistan 1i Nepal 1% Source: Immigration Department; total apprehensions were 52,037 3.55 Many of the workers who registered with immigration authorities, and received provisional work permits, never completed the process to secure machine-readable 2-year work permits-only 190,000 or 42 percent had such work permits by December 31, 1993. Half of the alien workers receiving work permits under this legalization program were in the construction sector. Table 3.8: Work Permits Issues by Sector: December 1lI-93 Sector Work Permits Issued Distribution Agriculture and Forestry 49,059 26% Constriction 95,366 50% Manufacturing 2,099 1% Non-government Services 43,741 23% Other (inci Mining) 78 0% Total 190,343 100% Source: MHR, Manpower Department A total of 47,000 illegal aliens registered and received temporary passes, but only 42 percent were issued work permits through December 31, 1993. 3.56 Malaysia's foreign worker policy since October 1991 has had a stop-go quality. Initially, only plantation, construction and households seeking maids-plus manufacturers on a case-by-case basis-could recruit unskilled foreign workers. However, other industries complained of labor shortages and requested permission to hire foreign workers, and in July 1992 restaurants, gas stations, and small factories were given permission to recruit foreign workers. In 1993, foreign workers earning M$700 to M$1000 monthly were required to pay Malaysians income taxes at the same rate as Malaysians, under the theory that they make use of Malaysian infrastructure. Beginning in 1993, foreign workers employed in manufacturing were required to pay a M$120 annual levy, while the levy for plantation workers was reduced from M$360 to M$300. - 80 - 3.57 In April 1993, unskilled foreign worker recruitment was suspended but, after a wave of protests, the recruitment freeze was lifted for manufacturers in June 1993. The purpose of the recruitment ban was to give the government time to re-assert control over illegal immigration. However, the ban may have backfired by promoting the use of labor contractors and brokers to obtain foreign workers--their raison d'etre in labor markets in industrial countries is often an ability to evade immigration and labor law enforcement. 3.58 Requests for foreign workers poured into the government from Malaysian employers. Between Marcn 1992 and December 1993, there were over 4,400 employer requests for 431,000 foreign workers. The MHR certified that 179,000, or 41 percent of these foreign workers, were needed. 3.59 A comparison of the distribution of work permits issued to illegal aliens who registered and employer requests for foreign workers demonstrates that manufacturing and agriculture are the two sectors that most want additional foreign workers: they accounted for 27 percent of the work permits issued to legalized workers, and 85 percent of the requests for additional workers. Manufacturing is the most dramatic case-accounting for 1 percent of regularized workers, and almost two-thirds of additional foreign workers requested. The MHR certified an above average percentage of requested foreign agricultural and construction workers, and below average percentages of manufacturing and service workers. 3.60 On January 7, 1994, when it was clear that the October 1991 registration, recruitment, and enforcement program had failed to stop illegal immigration, the legal recruitment of unskilled and semi-skilled foreign workers from outside the country was stopped. This recruitment freeze led to complaints from employers whose need for foreign workers had been certified, but who were not allowed to bring to Malaysia the foreign workers they were counting on. The government responded by permitting such certified employers to hire illegal workers who had been detected and were being held in camps, and by lifting the recruitment ban on skilled foreign workers needed by manufacturers. 81 - Table 3.9: Imnmigrant Workers Requested and Certified: March 1992-December 1993 Sector Entployer Requests Distribution Immigrant Workers Distribution Certified by Distribution Percent for inmmigrants Requested MHR Ceriified Agriculture and 492 11% 97,897 23% 50,687 28% 52% Forestry Construction 313 7% 46,876 11% 22,364 13% 48% Manufacturing 3,329 75% 265,553 62% 102,227 57% 38% Non-government 307 7% 20,164 5% 3,153 2% 16% Services Other (incl. 15 0% 866 0% 271 0% 31% Mining) Total 4,456 100% 431,356 100% 178,702 100% 41% Souirce: MHR, Manpower Department. The annual levy that must be paid for each legal foreign worker employed is MS420 except for agriculture (M$300), mnaids (M$360), and unskilled [M$360), semi (M$540) and skilled (M$900) manufacturing workers. Figure 9. Foreign Workers Issued Work Permits, Requested by Employers, and Certified: December 1991.93 70% 60%-- 509le - - 4099' - - 3096 - - 10% 0109S- 4-S Agriculture and Construction Manufacturing Non-goverunent Forcstry Services Pcrmits Issued---- 190,343 0 Workers Rquested--431.356 U Workers Certified-- 178,702 3.61 Today, there are three major issues surrounding Malaysian foreign worker policies: * Can employers count on the availability of foreign workers? The October 1991 policy was supposed to provide 5 years of access, but between April and June 1993, and again in January 1994, the recruitment of foreign workers was halted. * Will illegal immigrant workers continue to be available? Many illegal immigrants who registered did not receive work permits, suggesting that they are still in an underground economy in which - 82 - neither a levy is collected nor worker protections are available.L' * Will additional sectors, especially in manufacturing, be permitted to employ legal foreign workers? 3.62 There have been indications that the government is relaxing the ban on foreign workers. In March 1994, "skilled" electronics workers from Indonesia were admitted despite the fact that they were paid only M$400 monthly, below the average for such workers. In May 1994, the Rural and Development Ministry was permitted to import unskilled foreign workers for FELDA, FLCRA, and RISDA projects, even though the January 7, 1994 ban on unskilled foreign workers remains in effect(Business Times, May 24, 1994). D. Emigration: Stocks and Flows 3.63 Malaysia both imports and exports skilled, semi-skilled, and professional workers, making the country somewhat unique in its migration patterns. During the 1950s and 1960s, unskilled and semi-skilled Malaysians migrated primarily to Singapore-although part of the Malaysian Federation until 1966, Singapore maintained control over immigration. In the mid-1970s, perhaps 3,000 Malaysian workers-from dock workers to nurses-left for the Middle East, but the 1985 recession encouraged Malaysian workers to seek jobs in 'new' countries, from Taiwan to Canada(Pillai, 1992, 25) . Pillai notes that 'almost all" of these Malaysian emigrants are 'of Chinese origin' (1992, 25). 3.64 An estimated 150,000 non-professional Malaysians work abroad; two-thirds in Singapore. These workers earn 2 to 4 times the wages they would earn in Malaysia-for semi-skilled workers earning M$500 monthly or M$6,000 annually in Malaysia, an average doubling of wages would mean that Malaysia gains 6,000x150,000 or M$900 million annually in additional national income. Since many of Malaysia's non-professional migrant workers commute to Singapore, a commute that should soon be easier with an improved rail system, a second bridge link, and perhaps a 'smart' border-crossing card, Malaysia can take advantage of its proximity to Singapore by 'exporting' workers who are likely to return with most of their earnings. 3.65 Malaysians also work in Taiwan and Japan. Many of those in Taiwan are Chinese Malaysian construction workers; their number was estimated at 5,000 to 30,000 in the early 1990s. The number of illegal Malaysians detected in Japan was 4,500 in 1990. 3.66 Non-professional migration from Malaysia seems to represent special cases in which some Malaysian workers can earn high wages because of their location (near Singapore) or language and job contacts (Taiwan and Japan). The & Reportedly 100,000 of those who registered did not pay their levy (Straits Times, November 24, 1993, 19). - 83 - demand for non-professional Malaysian workers is limited by Singapore's size and its policy of upgrading jobs and skill levels which, if successful, will limit the number of unskilled foreign workers needed. The number of Malaysians who could find employment in Taiwan or Japan is larger, but both countries have ambiguous policies toward foreign workers, source countries such as China can offer far more workers, and the wage gap between Malaysia and these countries is narrowing. 3.67 It is unlikely that the number of non-professional emigrant workers will exceed 200,000-or 3 percent of Malaysia's labor force-and most of them are likely to return eventually. Their exit may require policy adjustments, such as managing employment of foreign workers in Johor, where wages are influenced by Singapore, and dealing with the exit of Chinese construction workers, but such adjustments should be in the nature of policy fine-tuning. Professional Emigrants 3.68 During the 1980s, an average 5,000 Malaysians annually were recognized as immigrants in Australia, New Zealand, Canada, and the United States. According to press accounts, these professional emigrants were among the 'best and brightest Malaysians-with advanced degrees, in their mid to late 30s, in middle or senior management positions, and with a monthly salaries of M$2,000 or more (Malaysia Business, April 16, 1988).1' 3.69 The emigration of professionals is influenced by economic conditions in Malaysia and the destination country, as well as the destination countries emigration policies. Australia and Canada admit some immigrants under a point system that makes entry easiest for young persons who speak English and have professional training. After the Canadian point system was introduced in 1986, and the Australian system in 1989, more Malaysian professionals emigrated to these countries(Pillai 1992, 28) . The United States revised its employment-based entry system in 1990, making it easier for up to 140,000 professional and skilled workers (and their families) from around the world to enter each year. 3.70 There are many reasons why professionals emigrate from Malaysia. The most obvious is that incomes are higher in the destination countries.' Yet W6 Of the 2235 Malaysian immigrants admitted to the US in FY1992, 1243 listed occupations, and 73 percent of those with occupations were professionals or managers. Of the 388 Malaysian immigrants who became naturalized US citizens in FY1992, 221 listed occupations, and 45 percent of them were professionals or managers. Ten percent of the 57,186 Malaysian non-immigrants admitted to the US in FY 1991 were students. Statistical Yearbook of the Immigration and Naturalization Service, 1993, 68, 104. 0' The Australian and Canadian recessions in the early 1990s, compared to the economic boom in Malaysia, have slowed such economically-motivated migration. Between mid-1992 and mid-1993, for example, only 1,555 Malaysians immigrated to Australia, versus 3,123 the year before (Straits Times, October 10, 1993, 18). In 1988-89, 7,681 Malaysian immigrants arrived in Australia. - 84 - there are many suggestions that non-economic factors also encourage the emigration of non-Malays. One carefully-phrased hypothesis is that 'the predominantly non-Malay migration out of multi-racial Malaysia is hypothesized to be mainly the result of an uneven opportunity structure for non-Malays in education and other government-related economic activities' (Gunasekaran and Sullivan, 1990, 53). Professional Malaysians seem to place a high priority on obtaining a university education for their children, and Pillai (1992, 30) notes that some professional emigration is motivated by 'a strong desire to provide children with an overseas university education' without having to pay steep foreign student tuition. 3.71 The number of Malaysian immigrants admitted to the United States doubled between 1982 and 1992, from 1000 to 2200. Another 5890 non-immigrant Malaysian students were admitted to the United States in 1992, more than from Pakistan (4038) and twice the number from Singapore (2598). The number of Malaysians admitted to Australia fell from 8030 in 1986 to 5860 in 1990. Malaysians were about 10 percent of the 25, 000 immigrants admitted to New Zealand in 1990/91. The other major destination country for Malaysian immigrants is Canada. Figure 10. Immigration to the United States from Malaysia and Asia: 1982=100 250 200 t I ; * ~Malaysians 150 --Ain 100 O. II I I I I I I ffi ov > 0% 0\ fi cz > f0 i - N Us +sU 0 @ 0 @ . 0 Source: SLaistical Yearbook of the Immipation and Nan=alizion Service. 1993, 30. 3.72 In addition to legal immigrants, Malaysians migrate illegally to these traditional immigration countries. For example, the estimated number of Malaysian illegal aliens in the United States almost doubled from 6000 in October 1986 to 11,000 in October 1992, making Malaysians almost 4 percent of the 300,000 Asian illegal aliens in the United States (Warren, 1994, 26). Most of these Malaysian illegal aliens are believed to be in New York (4000) and California (3000). 3.73 Fast-growing Asian nations such as Singapore, Taiwan, and South Korea have programs to encourage the return of professionals abroad. Instead of or in - 85 - addition to such programs, Malaysia could take steps that make staying home more attractive to potential professional emigrants. If Malaysia expanded opportunities to acquire a university education in Malaysia-perhaps by permitting private universities to operate-and reduced subsidies for study abroad, government revenues could be saved, local businesses could work more closely with higher education institutions to produce professionals with needed skills, and there would be less professional emigration. E. Regional Approaches to Trade and Migration 3.74 Malaysia is a recognized leader in promoting East Asian economic integration within ASEAN via AFTA. AFTA has no migration provisions, but Malaysia is the major destination for immigrants among AFTA member nations. 3.75 Migration is an increasingly important issue for ASEAN-AFTA countries, and it is not yet clear which regional forum will emerge as the focal point for multi-lateral discussions of migration issues, analogous to the EU in Europe. ASEAN's economic locomotives are considered to be Singapore, Malaysia, and Thailand, and these countries face to some degree a dilemma between potentially inflationary wage increases or opening themselves to migrant workers. There is the risk that too much migration could substitute a labor-led rather than the planned 'investment-led economic integration of the region.' AFTA labor-importing countries are likely to come 'under increasing pressure from labor-sending countries to introduce or enforce legislation that protects foreign workers from abuse and exploitation,' forcing them "to work with labor-exporting countries to control the flow of labor and the activities of labor-recruiting agencies,' perhaps through 'bilateral arrangements to manage the importation of foreign labor.' (Business Times, February 26, 1994, 4) F. Recommendations 3.76 It is clear that the extreme positions on immigrant workers in Malaysia are unrealistic. A total ban will worsen the already tight labor market and would increase wage escalation; plantations and construction would suffer in particular. An open door policy would encourage a rush of immigration given the income differential between Malaysia and migrant workers' countries of origin. This would be politically and socially unacceptable to the Malaysian host population. A rational immigration would have to take a judicious middle road mindful of the following: 3.77 In order to better manage the immigration and employment of foreign workers, Malaysia should: 3.78 Develop Transparent and Consistent Foreign Worker Policy. There is a great deal of confusion over Malaysia's immigration policies. As a result, there is misunderstanding among employers, unions, and Malaysian and non- Malaysian workers as to what the government's immigration policies are, and a certain degree of cynicism prevails that arises from contradictions between announced economic and labor market policies and the immigration reality. - 86 - 3.79 A clear horizon of continued immigration is needed instead of the present "stop-go" policy. That horizon is tied to the speed at which the economy makes the transition to high value added, high skills production wage. Explicitly recognizing the link between immigration needs and skills upgrading will help to define the horizon more clearly. 3.80 Buttreas Immigration Controls with Economic Incentives. Malaysia should consider an earnings-based foreign worker levy to generate funds to regulate the use of foreign workers and to improve the administration of foreign worker programs. 3.81 The Malaysian government must design its own policy, but one version of an earnings-based foreign worker levy can illustrate the concept. The employers currently have incentives to hire foreign workers. In addition to lower daily or hourly labor costs, employers realize savings by not making EPF contributions on behalf of immigrant workers; for an immigrant worker earning MS417 monthly or M5,000 annually, this 12 percent cost savings amounts to M$600 annually, or more than the current foreign worker levy." If employers paid this earnings-based levy on 500,000 foreign annually, M$300 million would be collected annually; on 1 million foreign workers, levy collections would total M$600 million annually."2' 3.82 An earnings-based levy system would be a flexible economic instrument that influences employer incentives to hire immigrant workers. Under such a system, employers would pay a percentage of the earnings of foreign workers into a government fund-perhaps to the EPF to simplify collection. The amount of the foreign worker earnings levy could be set to reflect (1) the fact that EPF contributions do not have to be paid on the earnings of foreign workers-12 percent-(2) plus any other savings employers realize by employing foreign workers, such as no annual bonuses, and no transportation allowances for e.g. construction workers housed on site. The employers would benefit from the levy because it would be used to streamline immigration administration to reduce the time for processing applications for foreign workers. 3.83 Foreign workers could also be encouraged to make EPF type contributions (like local workers). The accumulated amount would be available to them when they leave. This would facilitate adjustment of foreign worker demand in the business cycle. 3.84 Irprove the I±mmgration Data Base; The most widely cited estimates of the stock of immigrant workers are based on cross-sectional or one-shot assumptions about the immigrant share of employment in several economic sectors known to employ foreign workers. Studies are needed to assess the reliability La' There is an even greater incentive to employ foreign workers if the employer can pay the worker less because the immigrant worker does not have 10 percent of his earnings deducted for the EPF, and if the Malaysian employer deducts the annual foreign worker levy from the immigrant worker's earnings. ' The Immigration department reported that M$41 million were collected in 1992, and M$287 million in 1993. - 87 - of these immigrant share estimates, to provide indicators of how immigrant employment shares are changing over time, and to determine what enforcement strategies would deter unauthorized aliens from entering Malaysia and finding jobs. 3.85 Better data on immigrant stocks and flows could be obtained by modifying the establishment surveys currently used to obtain data on employment and earnings in the plantation, construction, manufacturing and service sectors. Since the data and anecdotal evidence indicate that foreign workers are disproportionately hired through labor agents or contractors, a major need is for more data, and for more reliable data, on foreign workers hired through such labor market intermediaries. The data base could also be improved by adding questions to the labor turnover survey to obtain information on worker movement between sectors in order to address questions such as how many immlgrant workers enter the Malaysian labor market through "easy" ports (plantations), and then move into construction jobs. 3.86 Regional Approaches to Trade and Migration: Theory and experience in Western Europe suggest that trade and investment can be a substitute for the migration of labor, i.e., the nations in a region can integrate without extensive labor migration. Despite freedom of movement guarantees, and policies that encourage migration within the European Union (EU), for example, fewer than 2 million citizens of one EU country are employed in another, making intra-EU migrant workers less than 1.5 percent of the EU's 150 million labor force. There is little intra-EU migration despite earnings gaps of as much as 1 to 5, as between Portugal and Germany, and.even larger gaps between, for example, rural Portugal and southwestern German cities (Martin and Ulmann, 1992). 3.87 In the first steps toward regional economic integration, growth is often uneven, creating labor shortages in boom areas, and displacing workers and peasants in other areas as industries privatize and restructure. Such uneven development within an economic region tends to produce an initial wave of labor migration, as occurred during the 1960s when Italians and Spaniards sought jobs in Germany and France. A similar "migration hump" is expected in North America as NAFTA accelerates economic integration there. 3.88 Malaysia has been a leader in promoting East Asian economic integration via AFTA. AFTA has no migration provisions, yet it will undoubtedly have effects on the migration flows underway in the region. Malaysia might wish to take the lead in considering how freer trade might affect migration into the country, since it is a major destination for migrant workers from AFTA countries. Such a forum is invaluable for checking illegal immigration into Sabah and Sarawak, since both effective policing as well as regional trade and investment patterns will be needed to stem the flow. - 88 - IV. INDUSTRIAL SKILLS TRAINING A. Introduction 4.1 Chapter 1 showed that not enough skilled labor is being produced to meet the rapidly growing needs of industry. This chapter examines that question in more detail. It first focuses on government policies to increase public provision of entry-level skilled labor, identifies several supply-side policy weaknesses, and makes recommendations to improve the public sector supply of skills training. This is followed by an evaluation of two policy instruments--a tax incentive scheme and a levy-grant scheme--designed to encourage companies to train their employees flexibly in response to changing market and technological needs. Several recommendations are made to improve the operation of these training schemes. This recent, demand-side policy emphasis is a promising development, and it has the potential for eliciting a greater private sector role in meeting its own industrial skill needs.. 4.2 A well functioning skills development system will have both short run and longer term benefits. In the short to medium term, an increased supply of skilled labor will ensure that labor productivity growth matches or outstrips recent increases in real wages caused by tight labor markets. Over the longer term, it will be critical for (a) restructuring industry towards higher value- added production, (b) developing technological capabilities needed to exploit new innovations and increase productivity growth, and (c) sustaining export growth based on entry into new markets and improved product quality and service. This view is reflected in the report of the Cabinet Committee on Training (1990). Many of its key recommendations--improving the responsiveness of public training to market demands, expanding the training role of the private sector, and building stronger linkages between training and technology--either have been, or are currently in the process of being, implemented. 4.3 The analyses and findings in this chapter concern the adequacy of these policy recommendations and the state of their implementation. Section 8 describes the institutional setting of public training in Malaysia, identifies the lack of coordination among the various public training institutions as an issue, and analyses the performance of training institutions in terms of the labor market outcomes of their graduates. Section C provides an overview of enterprise training in Malaysia and an analysis of two demand-side training policies--the DDIT (Double Deduction Incentive for Training) scheme and the newly implemented HRDF (Human Resource Development Fund) scheme. It characterizes the takeup of each scheme by firm size and subsector, and discusses recommendations for improving their effectiveness in encouraging more structured, firm-based training of employees. - 89 - B. SuDplv-side Issues in Industrial Skills Trainina 4.4 Malaysia's skill development strategy has, until recently, focused primarily on increasing the supply capacity of public education and training institutions to meet the skill needs of industry. Several supply-side issues arise. Will the current and planned expansion of the supply capacity of public training institutions be sufficient to meet the projected future demand for skilled workers, both at the basic and advanced skill levels? How cost effective is the public training system, as currently structured, in meeting this skills demand? Is public training relevant to the needs of industry, both at the entry- level and for the retraining and skills upgrading of the existing workforce? The following analysis provides some insights into these questions. Institutional Setting of Public Trainina 4.5 Table 4.1 provides an overview of the supply of skilled manpower in Malaysia from local public educational and training institutions. Between 1991- 1993, these institutions together produced a total of over 146,000 graduates. Of this total, educational institutions produced 47,000 with degrees (32 percent), 28,000 with diplomas (19 percent), and 14,000 with certificates (9 percent) . The remaining 57,000 or about 39 percent were produced in local public training institutions. Between 1994-1995, these institutions are projected to graduate another 151,000 skilled individuals, with the local public training institutions accounting for a significantly higher proportion (46 percent) of graduates. Considering only the graduates with technical/engineering-related trade training, that is, the skill group most in demand by industry, it is clear that public training institutions are the principal source of entry-level industrial skills. 4.6 These public training institutions play a relatively minor role in skills upgrading for the existing workforce. Between 1991 and 1993, they only provided skills upgrading to 920 trainees. Several surveys of employers in three regions--Klang Valley, Kedah and Perlis, and Pahang State--also revealed a low reliance on public training institutions for retraining and skill upgrading.Y' Despite differences in the level of industrial development across regions, employers reported that only between 2-7 percent of skilled workers scheduled for training in 1991 were to be trained in public training institutions. In-plant training was the principal source of training (58-93 percent). The two other major sources were training by the parent company (2-6 percent) and equipment vendors (2-13 percent), each source being as, or more, important than public training institutions. 4.7 Vocational and technical training is provided by a multiplicity of public training institutions under several ministries, each charged with specific areas of responsibilities and with carrying out their own skills training and vocational education programs. In total, there are 26 government industrial and skills training institutes. They include (1) 10 industrial training institutes (ITI) and the Centre for Instructors and Advanced Skill Training (CIAST) under i' Department of Manpower (1991), Survey of Industrial Skill Needs, regional reports. - 90 - the Manpower Department of the Ministry of Human Resources; (2) 9 MARA Skills Institutes (IKM or Institut Kemahiran Mara) and Pusat Giat MARA under the Ministry of Public Enterprises, and (3) 7 Youth Training Centres (YTC) under the Ministry of Youth and Sports. The Government has also set up two advanced training centers, the German-Malaysia Institute (GMI) and French-Malaysia Institute (FMI), in collaboration with the German and French governments. Finally, the Ministry of Education runs 70 vocational schools, 9 technical schools, and 7 polytechnics providing vocational education similar to that available in the public training institutions. Table 4.1: Output of Skilled Manpower by Education and Training Institutions Local Educ./Training Institutions. 91-93 % Total 94-95 % Total Educational. Institutions Degree graduates 46,810 31.9 43,038 28.4 Engineering-related 3,940 4,770 Diploma graduates 28,340 19.3 25,720 17.0 Engineering-related 5,540 6,670 Certificate graduates 13,900 9.5 12,900 8.5 Engineering-related 8,750 8,150 Public Training Institutions Skillsemi-ski graduates 57,600 39.3 69,970 46.1 Engineering trades 38,380 48,460 Skills upgrading 920 1,560 TOTAL 146,650 100.0 151,628 100.0 Source: EPU, Mid-Term Review, 1994. Table 4.2: Output of Skilled Manpower-Public Training Institutions Education/TraininR Instituinon 1991-93 1994-95 ITI (MHR) 6,940 5,659 Engineering trades 2,755 2,787 IKM (MARA) 9,905 8,225 Engineering trades 6,879 6,293 YTC (MYS) 1,254 n.a. Engineering trades 971 n.a. Technical Schools (MOE) 12,549 21,205 Engineering trades 9,478 15,057 Vocational Schools (MOE) 28,633 36,287 Engineering trades 16,221 22,653 Source: EPU, unpublished data. 4.8 Table 4.2 provides summary data on the output of skilled and semi- skilled graduates from these public training institutions. Together, the public training institutions under the Ministries of Human Resources, MARA, and Youth and Sports, currently produce about 7,000 trainees per annum in various technical skills, primarily at the basic and intermediate levels. The Ministry of Educations' s vocational and technical schools contribute twice as many per annum. All these institutions provide training in overlapping technical and trade areas, - 91 - including engineering trades (mechanical, electrical, and civil), building, printing, agriculture, and commerce-related trades. Of these, the engineering- related trades are most prevalent, making up roughly between half and two-thirds of all training provided in each public training institution. Basic versus Advanced Skill Training 4.9 Higher level skills will increasingly be needed for Malaysian industry to move towards higher value-added production. What role has public training institutions played in supplying these higher level industrial skills? Figure 4.1 provides a perspective on the supply of trained workers by level of skill from a variety of training institutions, both public and private. It shows, separately for basic and intermediate skill levels, the number of trainees taking the national trade tests between 1981 and 1993, and the corresponding number that passed. Not all trainees of public institutions take the trade tests administered by the National Vocational Training Council (NVTC), so this figure should not be interpreted as being representative. Nonetheless, it has larger coverage in including trainees from small training programs in other government ministries, the army training center, private training institutes, employers, and individuals. This latter group of providers are not inconsequential; in terms of output of skilled workers in 1993, as many trainees of private training institutes took the NVTC trade tests as did trainees from the Department of Mlanpower's ITIs (4,700 versus 4,695 trainees). 4.10 Recognizing their limitations, the test data indicate that there has been considerable expansion in the output of trainees at the basic and intermediate skill levels but not at the advanced skill level. The figure shows a five-fold increase in the number of trainees taking the NVTC trade test each year at the basic skill level between 1981 and 1993--from about 5,400 to 24,500 trainees by 1993. The corresponding increase in the annual numbers of test takers at the intermediate skill level was somewhat slower, rising from 1,200 to 4,200 trainees by 1993. The numbers taking the trade tests at the advanced skill level are too small to show up in Figure 4.1. The numbers rose from only 38 in 1981, to 120 trainees by 1993, when they represented just over half of one percent of all NVTC test-takers. 4.11 The low production of graduates with advanced level skill training is of concern. Highly trained technical personnel play multiple roles in industry, as supervisors, as trainers of other less skilled workers, and as implementors of new technologies. A shortfall in such highly skilled workers will have implications for the ability of companies to move towards higher-value added, more technology-intensive production. The Government has recognized this as an issue, and several centers for advanced skills training have been set up by various ministries, and by the Government in collaboration with Germany and France. However, even when they reach full capacity, their output of advanced level skills is unlikely to be very large. - 92 - Fig.4.1: Numbers Taking and Passing NVTC Trade Test 26 24- 22- 20- 16- L 14- 12- 10- 2 0 p p 1981 1982 1983 1984 1985 1886 1987 1988 1989 1990 1991 1992 1993 0 kuglc-taut + Basic-page 0 Into -test a Inter-pass Source: Unpublished NVTC data. Strenathenina Coordination of Training 4.12 In Malaysia, more needs to be done to improve policy coordination across the different training institutions, both public and private. The National Vocational Training Council (NVTC) was established in 1989 to promote and coordinate vocational and industrial skills training programs. The NVTC has initiated the setting up of interagency committees to consult on issues relating to training and trade certification, and has fielded several surveys which have a broader focus than the tracer studies which individual ministries have conducted for training institutions under their purview.y However, to date, the NVTC has not received adequate staffing and resources needed for it t.o play a leading coordinating role. It does not have the legal standing to coordinate training across public and private training institutions. Private training institutes are supposed to register with the Ministry of Education. Some private v They include tracer surveys of graduates from a broad spectrum of training institutions that sat for the MLVK trade tests, and a survey of the training needs of enterprises in response to the introduction of new technologies. - 93 - institutes do, but many others only register with the Registrar of Companies, so that little data are available on their training activities.3' 4.13 This coordination problem is not unique to Malaysia. Training systems in many countries are highly fragmented, with many different vocational schools and training institutions being operated by different agencies and preparing individuals for broadly similar occupations. Examples include Egypt, where vocational and technical training is provided by six different ministries, and Thailand, which opened the decade of the 1970s with two public vocational education systems and closed with four, all offering the same range of certificates and diplomas. However, international experience also suggests that a strong national training authority can play an important role in reducing duplication and improving the cost effectiveness of the public and private sector skills delivery system.4' Effective national training authorities are usually empowered to coordinate training across different public training institutions, and with participation from the private sector, develop strategic plans for training programs that complement key economic strategies, monitor labor market trends, conduct evaluations of training programs to adjust training to meet new skill needs, and develop and maintain databases on public and private training provision to estimate supply capacity. 4.14 In Malaysia, inadequate policy coordination raises questions about how efficiently resources are being allocated across training institutions. The issue is especially critical in the current economic context, with acute skill labor shortages and ever growing demands on the public education and training budgets. There have been recommendations that a National Vocational Training Law be enacted to strengthen the NVTC, perhaps based on Singapore' s VITB (Vocational and Industrial Training Board) . The VITB is responsible to the Singapore Economic Development Board and is empowered under the Vocational and Industrial Training Board Act, 1979, to be the national authority for the development, provision and regulation of industrial training, and the registration and regulation of apprenticeship training and private training institutes. These recommendations should be seriously considered. EvaluatinQ Performance of Training Institutions 4.15 One of the roles of a national training authority is to make recommendations about how resources should be allocated across different training institutions, based on analysis of their internal and external efficiency. In Malaysia, such an analysis should also recognize the potential tradeoffs between efficiency criteria and equity considerations implicit in the mission of the different ministries. On the most basic level, estimates of unit training costs can provide policymakers with rough tools to compare how much it costs different training institutions to produce a trained worker. In addition to unit training 3' The only data available on private training institutes come from periodic surveys of proprietary training institutes by the Department of Manpower, but the coverage is limited to the larger institutes only. 1' The World Bank, Skills for Productivity: Vocational Education and Training in Developing Countries, Oxford University Press, 1993, chapter 7. - 94 - costs, the performance of public training providers should be evaluated in terms of their external efficiency, that is, how well their trainees do--on standardized trade tests such as those administered by the NVTC, and in terms of labor market outcomes. 4.16 The findings of such an analysis is reported below, using data provided by the NVTC.5' It was not possible to compare unit training costs because there is no centralized collection of unit training cost data. The Economic Planning Unit maintains records on the development budgets of different training institutions, but not (except on an ad hoc basis), the operating budgets necessary to calculate and compare unit training costs across training providers.' As such, the comparative analysis is restricted to pass rates on the NVTC trade tests and to labor market outcomes. Performance on NVTC Trade Tests 4.17 Table 4.3 shows pass rates on the NVTC trade tests for selected years between 1984 and 1993 for five different training institutions--ITI of the Ministry of Human Resources, IKM of MARA, YTC of the Ministry of Youth and Sports, secondary vocational schools (SMV) of the Ministry of Education, and for comparison, private training institutes--and the total of all training institutions sending graduates for the trade tests.' The average passing rate for training institutions as a whole was 61 percent in 1993, though this figure changes from year to year. Particularly striking is the overall improvement between 1990 and 1993 in the pass rates of all training institutions. This is brought out most clearly in Figure 4.lb, which graphs the levels and changes over time in pass rates for the five major institutions and the total over the 1981 to 1993 period. '' Data on operating budgets of the different training institutions could not be assembled in time for this analysis. 6/ An effort was made to assemble operating budgets for training institutions under the different ministries, but not in time for this analysis. 2' The other smaller training institutions include the army training schools, PLK Johor, employers, and individuals. - 95 - Table 4.3: Numbers Taking Trade Tests and Pass Rates Trainine Institut Year Test Takers 1984 1987 1990 1993 ITI 1966 2265 2768 4695 IKM 3005 3894 5637 1313 YTC 524 925 1403 1702 SMV 483 2746 4020 16011 Private Institutes n.a. 1963 2215 4700 Total 9931 14166 20244 32860 Pass Rate (%) [TI 62.2 68.3 61.1 72.1 IKM 70.2 59.9 51.0 78.3 YTC 56.3 54.8 57.9 74.6 SMV 44.7 39.0 37.5 55.6 Private Institutes n.a. 45 1 39 6 58 4 Total 59.8 53.2 46.7 61.4 Source: Calculated from unpublished NVTC data. 4.18 In 1993, the pass rates on the trade tests (which are indicative of standards attained and not of cost effectiveness) were above the average for the three public training institutions--ITI, IKM, and YTC--and below the average for SMVs and private training institutes. As a group, the three public institutions had pass rates ranging between 72 and 78 percent, as compared to the average of 61 percent. Among them, IKM had the highest pass rate of 78 percent. This has not always been the case; IKM' s pass rates were lower than those of ITIs in the period between 1987 and 1990. The pass rate of SMVs has consistently been lower than that of public training institutions over time, though SMVs also showed a dramatic increase over time in pass rates--between 1990 and 1993, pass rates rose from 38 to 56 percent. The pass rate of private training institutes was only marginally higher at 58 percent in 1993. Fig. 4.1b Pass Rates oni tile MINK Trade Tests by Tra ining Institution 111 .IKU I KBN C-~~~~~~~~~~~~~~~~~~~~~~~~~~~- .15 l, l I- SMV P1 iv Total .75- U) U) l' .2 5 - 1 9 9 3 t9_ _ _ _ _ _ _ _ _ _ 1 9 9 3_ _ _ _ _ 1 9 _ _ _ 1 r T~ 1911 1 19837 2993 19E11 1¶JII7 1993 1901 1987 199] - 97 - Performance in Labor Market Outcomes 4.19 Here, the relative performance of training providers is compared in terms of four labor market outcomes of their trainees: (1) the probability of finding work after training, (2) time taken to secure a job, (3) monthly starting pay, and (4) relevance of training for work. An institution is judged to have relatively better performance if its graduates are more likely to find employment, take a shorter time to secure a job, receive higher starting pay, and find their training relevant to their job. 4.20 The analysis is based on a 1992 retrospective survey of over 4,000 individuals who took the trade tests administered by the National Vocational Training Council in 1991, that is, between six and twelve months prior to the survey.!' Since some trainees may not take the trade tests, analysis using this sample of test-takers should not be interpreted as reflecting outcomes for all trainees of these training providers. Training providers covered by the survey included ITI, IKM, YTC, IKK (Institut Ketukangan Kementah or army training centers), PLK Johor, private training institutions, employers, and other providers. For the analysis, the last two categories are combined. Table 4.4: Summary Data on Labor Mbrket Outcomes by Training Instkudon Workine Time to Find a Job Starlini Month Pav Ea Insiitules Samvie in <6 mch 6-12 mth 12+ m h <4 M 4-600 R601 + MfM. ITI 322 84.5 86.5 9.5 3.9 23.3 49.2 27.5 69.8 IlKM 670 67.6 82.4 13.5 4.1 29.7 43.2 27.0 75.5 YTC 81 66.7 83.3 10.4 6.2 34.7 42.9 22.4 77.8 SMV 2621 55.4 79.3 17.1 3.6 62.0 29.7 8.3 43.5 Pry. Inst. 159 89.3 66.9 20.3 12.7 15.8 35.3 48.9 80.3 IKK 40 60.0 65.0 30.0 5.0 10.0 65.0 25.0 37.5 PLK Job. 90 80.0 81.7 13.3 5.0 60.0 28.3 11.0 76.4 Other 108 71.3 71.7 18.3 10.0 37.5 35.9 26.6 75.3 Total 4091 62.2 79.8 15.7 4.5 47.7 35.2 17.1 56.7 Source: Simple tabulations of outcomes from 1992 NVTC survey. 4.21 Table 4.4 shows the distributions of trade test-takers in each of four labor market outcomes, separately by training provider. The first outcome is the percentage working at the time of the survey. The second to fourth outcomes are the percentages of trainees in each outcome, conditional upon working in 1992. The simple statistics shown in this table suggest the following points: 1) Probability of Working. Among public training providers, ITI graduates are most likely to be employed (84 percent), followed by graduates of PLK Johor (80 percent); among public training providers, SMV graduates are least likely to be employed, with only 55.4 percent s The National Vocational Training Council fielded this survey and kindly made the data available for analysis. - 98 - finding work in 1992. Of all providers, public and private, the graduates of private training institutes are most likely to find work (89 percent), with trainees from employers and other providers also doing well (71 percent). To the extent that many of the latter are already employees (e.g. private training institutes and employers), relatively high percentages finding employment might be expected. 2) Time To Find Work. Conditional upon working, ITI trainees are most likely to find work within six months (86.5 percent). Trainees from most of the other public institutions, including SMV, also find work within six months when they get a job. Trainees from private institutes are more likely to find work, but they appear to take longer to find employmrent (67 percent versus the sample mean of 80 percent finding work within six months) . There does not appear to be an obvious explanation for this finding. 3) Starting Pa . Conditional upon working, trainees of ITI, IKM, YTC and IKK are most likely to get starting pay of between R 400-600 (43-65 percent) while SMV and PLK Johor trainees are most likely to get starting pay of less than R 400 (60 to 62 percent). In contrast, trainees from private training institutes are most likely to get starting pay greater than R 600 (48.9 percent). Some of these variations in starting pay may simply reflect location effects, an issue addressed below. 4) Relevance of Training to Work. Conditional on working, training provided by most public training institutions (except SMV and IKK) was reported to be relevant to their work for about 70-78 percent of graduates. This figure is roughly consistent with the range of estimates of training relevance--between 50 and 75 percent--reported in studies of vocational school graduates in the United States. For graduates from SMV and IKK, this figure was much lower, in the 37 to 44 percent range. As before, the graduates of private training institutes were most likely to report the relevance of training to their current job. 4.22 These simple comparisons are useful but potentially misleading. They do not take into account differences between training providers. They serve different student groups, varying by sex, trade areas, skill levels, and regional markets, all of which can have an impact on measured labor market outcomes, independent of the training efficacy of the institution. A training institution may appear to perform well because its graduates are located in areas of high labor demand and starting pay, as compared to other training institutions situated in more rural and remote locations. Private institutes, for example, will rationally select locations (e.g. industrialized urban areas) with the greatest demand for their services, and with good prospects for job placement and high starting pay for their graduates. Many public education and training institutions, on the other hand, may locate in less favorable areas to better serve less advantaged populations. Therefore, account should be taken of these other variables in comparing the relative performance of different training providers. 4.23 Table 4.5 shows the corresponding outcome distributions by training provider once explicit account is taken of other factors such as sex, skill - 99 - level, trade area, and state of residence. The predicted labor market outcomes are based upon parameters estimates of several regression models (see Annex 4A), and the assumption that trainees from all training provider have the sample means of all factors except where they got training.2' Sample means will primarily reflect the characteristics of SMV trainees (by far the largest group), so the predicted outcomes for them will be largely unchanged. Figures 4.2 and 4.2b graph the predicted and observed outcomes to show how corrections for these other variables affect judgements about the relative performance of different public and private training providers. Table 4.5: Predicted Labor Market Outcomes From Regression Analysis Workine Time to Find Job Starring Monthly Pay Job Institute Sample in 1992 <6 mth 6-l2mth 12+ mt cR40 R4I0 R601 + &Lv ITI 322 79.8 85.5 11.8 2.5 36.0 43.8 20.1 66.7 [KM 670 63.6 82.2 14.1 3.5 36.1 43.8 20.0 77.6 YTC 81 68.7 81.7 14.5 3.6 36.7 43.6 19.5 75.2 SMV 2621 52.1 79.5 16.0 4.3 62.9 30.7 6.3 46.2 Prv. Inst. 159 78.6 64.7 24.8 10.3 22.2 44.4 33.3 75.8 IKK 40 42.2 69.3 22.4 8.2 33.0 44.4 22.4 33.4 PLK Joh. 90 64.3 78.4 16.8 4.7 66.4 28.2 5.2 74.3 Other 108 70.6 70.4 21.7 7.7 37.1 43.5 19.3 76.2 Total 4091 58.2 79.6 15.9 4.4 51.4 35.9 12.5 57.8 Source: Predictions from regression models assuming that all trainees have the sample means of all other variables except for where they got training (see Annex 4A). Several results are suggested: by these graphs: 1) Group differences in the composition of sex of trainees, skill level, trade areas, and state of residence have an impact on measured labor market outcomes. Controlling for these factors both reduces the variation in outcomes across institutions, and changes the relative ranking of individual training institutions. Thus, simole comparisons aive misleadino conclusions about the performance of various public institutions, and about the relative performance of public versus private training providers. 2' This assumption is necessary but a little counter-intuitive for state-specific providers such as PLK Johor. - 100 - Fig.4.2: Actual and Predicted Percent Workr I n Ir 192 70 80 20 ! ~ ~~~ It E ( - Prv . I nut. JlC PLr Jl.0j | D~~~~~~ Job In IN92 + PNredicted Source: Unpublished NVTC data and author's calculations in Annex Tables 4A.1 and 4A.2. Flg.4.2b: Other Observed and Predlcted: 40 swo 40- 3 D \9 A 20- 10 D LP IrN I P t. PLe Joh. s W o FM BOB. + P-F* oov in 1 tv t Ptotl vu Source: Unpublished NVTC data and author's calculations in Annex - 101 - 2) The estimated labor effects of the control variables (reported in Annex 4A) are of some interest. First, they suggest that while female trainees are more likely to receive lower starting pay, their training is more likely to be relevant to work. This result may reflect a concentration of female trainees in low-paying gender-typed jobs such as hair-dressing. Second, compared to basic skills, higher level skill training improves all measured labor market outcomes. Third, trainees with engineering and draughting-related trade training appear to perform best in most outcomes. Finallv, compared to the rest of the country, trainees residing in Perak, Johor, Penang, Kuala Lumpur and Melaka are more successful in finding employment and higher paying entry-level jobs. Unless these locational effects are taken into account, those training institutions that serve outlying regions of the country for equity reasons will score less well in terms of labor market outcomes. 3) Among public trainina institutions, the relative ranking of ITI, IKK, and YTC trainees in most outcomes is largely unchanged, as in the proportions finding work (the range falls from 67-85 percent to 69-80 percent). However, the differences between them are greatly reduced, or in the proportion of trainees getting starting pay of R 600 or more, completely eliminated (the range falls from 22-28 percent to 20 percent for all three groups) . The high relative performance of PLK Johor graduates declines, as in the proportions working (from 80 to 64 percent) and getting starting pay of over R 600 (from 11 to 5 percent), possibly reflecting the favorable labor market conditions in that state. SMV graduates, as before, rank lowest among all the different groups of trainees in all labor market outcomes. 4) Comparing graduates of public and private trainina institutions, the record is mixed as before, though the differences between them are now greatly reduced. Compared to the ITI, IKK, and YTC, some outcomes of graduates from private institutes are poorer (time to find a job); others are comparable, as in the proportion working (79 percent for private graduates and 80 percent for ITI) and reporting training to be job relevant (76 percent); and other outcomes are better, as in the proportion with starting salary of R 600 or more (33 percent versus an average of 20 percent in the three public training institutions). 4.24 This ranking of labor market performance--first, private training institutes, then public training institutes, and finally vocational education schools--appears to hold in many other developing countries as well.-L' Several factors are thought to be responsible for this common, but by no means universal, finding. Vocational schools tend to have low curriculum flexibility while markets demand frequent changes; they face constraints on instructional innovation posed by semester scheduling and credit accumulation; difficulty in attracting qualified instructors because of civil service pay scales; and an inward focus on education rather than on the needs of employers. Public skills trainino institutions have several advantages, including shorter course 1'W The World Bank (1993), op. cit. - 102 - offerings; freedom from time-serving requirements of formal education; flexibility in scheduling and curriculum redesign as demand changes; and close links with the private sector through in-service practical training for their graduates. Private trainina institutes, while often of variable quality, have the most flexibility in adapting quickly to changing market conditions, and they can attract qualified and experienced instructors by offering market pay scales. A study should be conducted to investigate these hypotheses and their efficacy in explaining the Malaysian findings. Policy Implications. 4.25 The overview of industrial skills training and analysis of the relative performance of public training institutions suggest the following implications: 1) Coordination amona training institutions should be strengthened to avoid duplication and improve cost efficiency in resource allocation. The NVTC was set up for this purpose. It needs to be strengthened further in terms of staffing, resources, and capabilities for policy analysis. Concrete steps should be taken to implement previous recommendations for a National Vocational Training Law to enhance the NVTC's authority and role in coordination of training across both public and private training institutions, trade testing, and certification of skills. The NVTC has already taken steps to improve trade testing, certify previous learning and experience, and to introduce NOSS (the National Occupational Skills Standard) to replace the existing system. 2) Careful analysis of internal and external efficiency in training provision should be conducted on an ongoing basis. These analyses should help policymakers identify potential problem areas to be resolved, develop training strategies, and improve resource allocation both among training institutions under one ministry, and across institutions under different ministries. Data on unit training costs should be collected and analyzed on a systematic and system-wide basis. Broad based tracer surveys, such as those used in the analyses, are an important source of data on how graduates from both public and private institutions fare in the labor market, and should be conducted on a regular basis by the NVTC. 3) There is considerable variation in performance of different training institutions as measured by the entry level labor market experiences of their trainees. In terms of these measures, the three principal public training institutions (ILP, IKM, and IKBN) do quite well as compared to SMVs, though private training institutes appear to come out ahead in terms of finding employment and higher starting pay. In terms of the relevance of training to work, the public and private training institutions appear to be on par, with the SMV and IKK training being most likely to have low job relevance. The relatively low performance of SMV graduates on all outcome measures is of concern, and requires further careful study especially since - 103 - vocational schools provide the single largest source of skilled technicians. 4) There should be systematic and on-going collection of information on skills training provided by Drivate trainina institutes. This may be achieved through the enactment of the National Vocational Training Law, and registration of private training institutes with the NVTC. A streamlined reporting system should be developed, for monitoring purposes and, more importantly, for providing policymakers with training data needed to plan effectively. C. Demand-Side Incentives for Training 4.26 Policymakers recognize the critical importance of worker retraining and skills upgrading if industry is to move towards higher value-added, and more capital and technology-intensive production. Given the limited role of public training institutions in retraining and skills upgrading of the workforce, the Government has implemented two training incentive schemes--the DDIT (Double Deduction Incentive for Training) scheme and the HRDF (Human Resource Development Fund) scheme--to encourage companies to play a greater role in meeting their own skill needs. 4.27 Several issues arise in evaluating these incentive schemes. How much training goes on in industry, in which firms, and is there any evidence of market failure requiring policy intervention? Have the two schemes had a salutary impact on the amount of employer-sponsored training, and can they be made more effective? The following analysis first characterizes the incidence of training by firm size and sub-sector, the relationship between training and technology, and the most important sources of training and skills upgrading for employees. With this as background, the DDIT and HRDF schemes are analyzed, focusing on the takeup of schemes by firm size and sub-sector, and several recommendations made to improve their implementation. Incidence of EnterDrise Training 4.28 There is little data on employer training in Malaysia, exceptions being the 1988 Malaysia Labor Market Flexibility Survey and scattered surveys of employers fielded by various government agencies. The 1988 survey is a large, broad-based survey of over 3, 000 manufacturing establishments containing detailed information on their wages, labor practices, and training. While dated, this survey nonetheless provides a snap-short of firm based training at the time the DDIT scheme was first being implemented. Data from this survey are used to characterize the incidence of enterprise-based training by firm size and by industrial sub-sectors.-L ui Data used are tabulations from Guy Standing, Adiustment and Labor Flexibility in Malaysian Manufacturing, Malaysian Human Resource Development Plan Project, 1990. - 104 - 4.29 The 1988 survey indicated that while entry-level training is quite common, formal structured training to upgrade worker skills is not, except in large, typically multinational manufacturing firms. In over two-thirds of manufacturing establishments that train, the main type of training is informal on-the-job training whose quality and durability may be questioned. In many evaluations of the returns to the different types of training, the impact of informal on-the-job training is invariably small if not non-existent; on the other hand, there is strong empirical evidence that formal structured company training has the largest impact on earnings, followed by other institutionalized training. 12/ 4.30 Figure 4.3a shows, separately by firm size, five measures of training: (a) entry-level training, (b) retraining at the same level of skill, (c) retraining to upgrade skills, (d) the proportion of firms providing training to between 0.1 and 5 percent of employees, and (e) the proportion training over 5 percent of employees. Entry-level training is relatively common, even in small firms, because firms need to familiarize new hires with the specific equipment and work practices in use in the enterprise. Retraining and skills upgrading, on the other hand, is highly dependent on the technology of the company--whether new products, processes, and equipment (especially computer-aided) are being introduced--and on competition in product markets, both domestically and internationally. The evidence from micro studies of employers' training decisions suggests that when the pace of technological change is rapid and firms are actively involved in exporting, the demand for new skills and retraining increases. 13 4.31 Figure 4.4a provides insights into this hypothesis. It shows, separately by firm size, the percent of firms expanding the range of products offered and introducing new, more technologically sophisticated equipment. It also shows the percent of employers responding that these efforts had the effect of increasing the skill content of jobs. On average, small and medium size firms are less likely than larger firms to have introduced new products or installed technologically sophisticated equipment, or to report an increase in skill content of work. Not surprisingly, smaller firms are less likely than larger firms to retrain and upgrade the skills of employees; when they did, smaller firms provided training to a smaller fraction of their workforce. Another factor not shown in these figures is export orientation, which is positively correlated with the propensity of companies to train, and negatively correlated with firm size. IV For evidence from developing countries, see references cited in World Bank (1993), Skills for Productivity, chapter 2; for evidence from industrialized countries, see Tan et al, Youth Training in the United States, Great Britain, and Australia, Research in Labor Economics, 1993. 12' This evidence is based on an ongoing cross-national study of EnterDrise Traininc Strategies by the World Bank, and a study by Aw and Tan (1993), Training. Technologv and Productivity on Taiwan. - 105 - Fig.4.3a: Proportion of Firms Tralning 70 - so 40 30 20- '1-20 21-50 54-100 '10-1-250 254-SO 501. vI oyntent Size of COiminIeo o Entry lIeel + 5am Iwol o Lauad. lI.*l A 0.1-V1 Ir,er x 5.1.U workers Source: Guy Standing (1990), op. cit. FTg.4.3b:Percent Training by Sub-sector 90 70 so 40 30 20 Food&h bv wood fLn chwm'ici "c'm.tea i.iriconice o 11Fty Iev*I + So.* I..wI 0 Ligr-ade l11 A 0. 1-916 wkers Source: Source: Guy Standing (1990), op. cit. - 106 - Ftg.4.4a: Product Pange, New Technology ond Job Ski Il Content 70 SD - 40 30 20 X ;~ ~~~~20 21-SO 5-10 1a 01_250 25'%-500 501+ ; rployment Size 0 Producte + Now Tech o ScIIl I content Source: Guy Standing (1990), op. cit. FIg.4.4b: By Sub-sector 80 70 - so t>ut Tc o Ai otn 40 - 20 20 Text. ape. Pprot Nnaue. Pw...L. . OtChR*r emnuf. a R'oducta + Mr*-Tech o silli content Source: Guy Standing (1990), op. cit. - 107 - 4.32 Figures 4.3b and 4.4b explores this hypothesis at the sub-sectoral level. They show wide variations in enterprise training and technology across industrial sub-sectors. Firms in the wood products and non-metals sub-sectors rank lowest in all five measures of training; on the other end of the training scale are firms in the electrical machinery sub-sector, which is dominated by large, mostly multinational electronics companies. This same ranking of sub- sectors is found in terms of the proportion of firms introducing new products and new technologically sophisticated equipment. These figures suggest that firms in the most technologically progressive sub-sectors, such as electric and electronics, are also the most prolific trainers; conversely, firms in sub- sectors with low levels of technology provide, on average, relatively little training. Do Malaysian companies under-invest in traininQ? 4.33 Policymakers clearly believe that Malaysian companies under-invest in training, especially in relation to the current and projected skill requirements of rapidly changing technology and growing international competition. A case can be made to support this view, drawing upon the above discussion. Three arguments may be made: (a) technology-related externalities from training; (b) market imperfections, in worker retention and imperfect information; and (c) weak training capacity of domestic firms, especially smaller enterprises. 4.34 The first argument--technological externalities related to training-- rests upon the view that a great deal of technology is embodied in worker skills. New technology usually requires extensive modification and adaptation before it can be effectively used, and productivity gains realized, a process that involves continuous learning and training on the part of all workers, from engineers down to production workers. Just as firms do not spend socially optimal amounts in R&D (research and development), because they are unable to fully internalize the benefits of their investments (technology spillovers also benefit other firms), so a similar argument can be made that firms under-invest in training related to technological innovation. These positive technological externalities justify government involvement in mobilizing increased enterprise training through training subsidies or tax incentive schemes such as DDIT. 4.35 The second argument is that firms underinvest in training because of market imperfections in worker retention and information. One argument commonly heard in Malaysia is that 'poaching' of trained workers by other firms prevents employers from recouping training costs, and results in under-investment in training. Many economists dismiss this view, arguing that firms only poach workers with general (and transferable) skills, but this would not impose costs on firms that train since they will shift the costs of general training to workers through lower wages. These objections are diluted, however, if most skills are industry-specific or specific to particular technologies-, in which case there can be under-investment in skills from high levels of job mobility. 1' See Tan, Human Capital and Technological Change, 1980. - 108 - The appropriate policy response is to provide incentives for non-training firms (mpoachers) to train, or to share the costs of training provided by firms or other training institutions. A number of countries have use payroll levies, either with public provision of training--the Latin American model--or with rebates for approved training expenses, the form preferred by other countries. Malaysia's HRDF scheme falls into this latter category. 4.36 Imperfect information, especially about new technologies and training (both the value of training, training needs, and training pedagogy), can also lead to under-investment in training. Arguably, both technology and training are experiential forms of knowledge, requiring learning-by-doing. To the extent that these forms of knowhow are often not codified, and furthermore have value in the market place, there will be incentives for the private sector to monopolize this information. This results in less than socially optimal diffusion of best practices, both in technology and in training knowhow, and consequently, under- investment in training and technology. The appropriate policy response is to improve the dissemination of best practices in technology and training knowhow, through industrial extension services, through employer associations and industry groups, and through matching grants for firms or groups of firms to seek out best practices. Many of these policy instruments are already in place in Malaysia, though their takeup by the private sector has not been encouraging.5L' 4.37 The third, arument is that relatively weak management and training capabilities of domestic companies, small firms in particular, have lead to under-investment in training. Certainly, there is evidence that many otherwise similar domestic companies are less likely to train as compared to multi-national firms. This, however, may simply reflect the appropriate amount of training given their level of technology, and not weak management or training capabilities. A stronger case can be made for small firms. Small firms are especially vulnerable to several market imperfection in training--lack of access to credit to finance training, poorly developed management and training capabilities, lack of information on appropriate technology and training and training pedagogy, and high fixed costs (no scale economies) in developing training programs for a few employees. The appropriate policy response here is providing an integrated package of financial services, technical assistance, education (through outreach and extension services), and facilitating low-cost group training through industry associations, consortia of small firms, or in collaboration with larger enterprises.LW' 4.38 In summary, there appears to be some support for the view that Malaysian industry generally under-invests in training. In 1987, the Government introduced the first of two incentive schemes to increase training of employees. The DDIT was the principal policy for training between 1987 and 1993, and it permitted firms to deduct double the amount of allowable training expenses on 2 See Ministry of International Trade and Industry, 1993 International Trade and Industry Report. U MITI is currently developing a SME (small and medium enterprises) census and study to better understand the problems of SMEs and to develop programs to address them. - 109 - their income tax returns.217 When HRDF was established in 1993, the DDIT incentive scheme was retained for manufacturing firms with less than 50 employees, and HRDF became the principal policy instrument for larger firms. In the following sections, the two training policy instruments are described, and their implementation, coverage, impact, and output of trainees assessed. It concludes with policy implications and recommendations. The DDIT Scheme 4.39 There are two ways in which the DDIT scheme can be used: first, by sending employees for training in approved training institutions, second, by applying to MIDA (Malaysian Industrial Development Authority) for approval of planned training programs. Firms sending employees for training in approved training institutions are automatically qualified to claim the double deduction incentive directly from the Department of Inland Revenue.1!' This facilitates use of the incentive scheme, but because there are no reporting requirements, little direct information is available about the use of, and number of employees trained through, DDIT approved training providers. Information about DDIT use through the second route is much better developed. Between 1987 and 1993, MIDA approved a total of 591 inhouse training programs, involving 3,253 trainees and costing a total of just under RM 32.5 million. Over this period, just over 35 percent of applications for inhouse training were rejected for being incomplete or inadequate. 4.40 The DDI scheme has evolved over time, with an expansion in the number of approved training providers, and the addition in 1991 of two additional types of training that would qualify for the DDIT scheme. These changes were made in response to criticisms about the DDIT approval process, specifically that the types of training that qualified for DDIT were excessively restrictive. Originally, training programs had to be directed at either (1) development of craft, supervisory and technical skills for the manufacture of new products or processes, or (2) upgrading of craft, supervisory and technical skills in existing products and processes. In 1991, two broader categories were added: (3) production-related training for productivity improvements, and (4) training for quality improvements in production. MIDA reportedly has also simplified the application process and reduced reporting requirements.'9' 22' Employers already deduct training expenditures as a business expense, but the DDIT scheme allows them to deduct an additional amount equal to eligible training expenditures. o'/ There are currently 12 approved training institutions: the National Productivity Corporation, SIRIM, Mara Institute of Technology, Malaysian Agricultural Research and Development Institute, Forest Research Institute of Malaysia, Centre for Instruction in Advanced Skill Training, Penang Skill Development Centre, IKM, Industrial Training Institutes, German-Malaysian Institute, Malaysian Timber Industry Board, and Perak Entrepreneur and Skill Development Centre. L9' Based on interviews with MIDA staff. - 110 - 4.41 These changes--in the scope of permissible training, in the number of approved training providers, and in the application process--were associated with a sharp rise over time in the number of DDIT applications and a decline in the rate of their rejection by MIDA. See Figure 4.5a. The number of applications rose from 37 in 1991 to 214 in 1992, and to 392 in 1993. The rejection rate of training applications declined over time, from a high of over two-thirds (69 percent) in 1988 to the 22-25 percent range in the early 1990s. Expansion in the scope of eligible training programs also showed up in changes in the kinds of workers getting trained. Especially striking is the growth in training of 'other' categories of workers (typically production workers), the group most likely to benefit from addition of training criteria (3) and (4). Fig.4.5a: DOIT Program App[ications 3220 30O 2800 250- 240- 220- 200- & 150 Soure: nne tale B.1 120 Bso 55 20 o 1558 *9893 1950 '99i 1992 1993 Source: Annex table 4B.I. - III - Fig.4.5b:DOIT Trainees by Training Type 7Ds $DO- 500- 100 = 1906 19g9 1990 1991 1992 1993 Clraft. i smar 0 engIn A tneh X oth-r Source: Annex table 4B.1. Assessment of DODT 4.42 Several questions arise in assessing the efficacy of DDIT as a training policy. How effective was DDIT in encouraging employer provision of training? Were many firms induced to begin training, or to increase training, by public subsidization of training costs? Or was the incentive simply a windfall for employers who would have trained anyway, even without DDIT? Furthermore, now that DDIT is the only training policy for companies with less than 50 employees, will DDIT be an effective policy instrument for small firms? These questions are addressed below. 4.43 First, recognizing that data are not available on training taken through approved institutions, it is still evident that the takeup of DDIT through MIDA has been extremely limited, notwithstanding the dramatic rise in the number of training programs approved since 1991. Statistics on approved programs overstate the number of firms that utilize DDIT since firms can, and do, submit multiple applications. For example, the 317 training programs approved by MIDA between October 1988 and March 1993 were filed by only 159 companies. The cumulative number trained through MIDA approved DDIT programs up the end of 1993 only totaled 3,253 workers, over half of this in 1993. - 112 - 4.44 Second, the takeup of the DDIT incentive has been very uneven across subsectors, with firms in electric and electronics being the primary beneficiaries of DDIT. Between 1988 and March 1993, the electric and electronics sector accounted for 181 out of the 317 training programs (or 57 percent) approved by MIDA. The chemicals, non-metallic products, and transport equipment subsectors were the other principal users of DDIT, but they had significantly fewer programs--26, 22, and 21 programs, respectively. On the other end of the scale, the beverage and food industry had no programs approved. In terms of number of trainees, the electric and electronics subsector accounted for 898 out of the 1,735 workers (52 percent) trained through these programs. 4.45 Third, DDIT use has been dominated by multi-national companies, primarily in the electric and electronics subsector.52' Out of the 68 firms that filed applications in 1992, 33 (or 48 percent) were wholly foreign-owned, 8 (12 percent) were majority foreign-owned, and 1 (2 percent) had equal foreign- Malaysian ownership. Of the remaining companies, 21 (32 percent) were majority Malaysian-owned, and 5 (7 percent) were wholly Malaysian owned. These ownership patterns, and the uneven takeup of DDIT across subsectors, raise questions about the design of the DDIT incentive scheme, and whether it has been effective in encouraging new training among domestic, and less training-intensive firms. Arguably, as suggested by the 1988 survey of labor market flexibility, most multi-nationals and majority foreign owned firms would train even without the DDIT incentive, given the high-tech subsectors in which they operate and their production for export markets. In the other domestic-oriented subsectors and in the larger population of Malaysian-owned companies, where skill levels are generally lower, the small takeup of DDIT suggests that this incentive scheme has generally been ineffective in encouraging training. 4.46 Fourth, the takeup of DDIT by small companies has reportedly been very low.3' This pattern of use by firm size is important since, effective June 1993, only companies with less than 50 employees will be eligible for DDIT. A crude attempt to characterize the size distribution was made by matching lists of company names of DDIT applicants with a master list of companies in operation in December 1992 that contained information on employment size. Table 4.6 shows the size distribution of DDIT applicants for the sample where name matches were made.w The data suggests, first, that over the 1988 to 1994 period, only a small proportion of DDIT applicants (9 firms or about 6.8 percent) were small companies with less than 50 employees. Companies with 50-99, 100-499, and 500 or more employees accounted for 22, 30 and 41 percent of the matched sample of firms, respectively. L' MIDA 1992 Annual Recort, p. 102. a' This perspective is based on MIDA' s experience in processing DDIT applications. It did not collect information on firm size prior to 1993, but is now eliciting this information in DDIT applications. W Only 133 companies out of 189 DDIT applicants (about 70 percent) could be matched perfectly by company name, possibly because of company name changes, entry and exit of firms, or reorganizations. 113 - Tabb 4.0: Employment Sln Dltributsn of DDIT Appikants DDIr Aalicaw Comoanieserof Emakvees <50 50-99 100-499 500+ Number of companies 9 29 40 55 Distribution(percent) 6.5 21.8 30.1 41.3 Source: MIDA, sample of DDIT applicaot. 1988-1994. 4.47 These variations in DDIT takeup across subsector, ownership, and firm size may be attributable, in large part, to economic factors.U' However, the low levels of takeup, and their changes over time with program modifications, suggest that the application process itself is playing a role. Specifically, many companies may not find the incentive attractive because the incremental cost of applying far exceeds the additional benefits of applying for DDIT. On the cost side, companies must (1) commit time and other resources to meeting application requirements,2' including the stipulation that submissions be made to MIDA within 3 months of training completion, and (2) pay for an external auditor to certify expenditures each time an application is made. On the benefit side, the company is able to claim an additional write off of less than 100 percent (because of limits on certain cost categories) if the apolication is aunroved. In 1993, MIDA rejected 22 percent of DDIT applications, so the expected benefits of applying should on average be discounted by this probability of rejection. 4.48 For small firms--the new target population for DDIT--this cost-benefit calculation may be even less attractive. Four factors may be important. First, many small firms may operate close to the break-even point, and having no taxable income to shelter, would not find DDIT attractive. Second, when only a few employees are being trained, as is usually the case with small firms, auditing fees for DDIT applications can eat up the entire amount to be claimed.&' Third, high fixed costs of training, coupled with weak training capabilities, may not make training cost-effective for small firms. Finally, many small firms operate in the informal sector, and judge the foregone DDIT benefits to be small as compared to the potential costs of applying to MIDA, namely, inviting closer government scrutiny of their activities and regulation on matters such as location, adherence to environmental regulations, and labor issues. E3 See the discussion of the economic determinants of company-based training in Section C. Y' Companies must include details of the training undertaken (including syllabi and course content) , training providers, training contract. list of employees receiving training, type of training, training duration, and a detailed cost breakdown by allowable categories. B' This aspect is reportedly one of the major complaints about the DDIT application procedure. - 114 - 4.49 Malaysia's experiences with DOIT are not unique. Many countries have used training subsidies or tax write-offs of training expenses to encourage firms to train, including Argentina, Brazil, Chile, Fiji, Pakistan, and the Philippines. The limited evidence suggests that they often needlessly subsidize well run firms that already train, while poorly managed firms either do not respond or respond by establishing training designed more to maximize financial gains than to develop needed skills. Evaluations of these programs in Chile and Brazil indicate that the main beneficiaries are large firms in the most dynamic sectors of the economy.Z&' Policy Implications for DDIT Scheme 4.S0 The analysis suggests the following implications for policymakers: 1) Large multi-national firms appear to have received sizeable windfall gains from DDIT. Given the technology-intensive nature of their production, coupled with their export orientation, most would have trained their workforce even without the benefit of this incentive scheme.2' The issue is moot since larger firms with 50 or more employees are now covered under the Human Resource Development Fund. 2) Unlike DDIT applications through MIDA, no data are available on training through the 12 DDIT approved training providers. This knowledge gap--about levels and types of training and about the firms that use it--precludes a more definitive assessment of the incentive scheme. An effort should be made to develop such a data base. 3) Given past trends, the data suggest that MIDA will get no more than a handful of DDIT applications each year from small firms with less than 50 employees. Unless small firms make extensive use of approved training providers, and it is unclear that they do, it must be concluded that the DDIT incentive scheme is an ineffective policy instrument for this group of companies. Policymakers have several options. 4) The first option ift to streamline the apolication orocess for DDIT. This might involve automatic approval of applications, with the requirement that all DDIT users submit annual statements to MIDA reporting trainmng tarough approved training institutions and through ad-hoc traininc procrams. Firms would be required to maintain detailed records suteCct to unannounced, periodic spot-checks for compliance. This wquld reduce reporting requirements, costs, and L' World Bank, Vocational EducatIon on the Threshold of the 1990s, commissioned study by CINTERFOR and ILO, volumies I and II, 1991. ' Enterprise surveys in many countries, including Indonesia, Mexico, Colombia, and Taiwan, have found that larger firms and firms with foreign ownership are more likely to train their workers, presumably even without tax credits for training. - 115 - uncertainty for users, free MIDA from the administrative burden of approving every application, and provide policymakers with data needed to monitor trends in the use of DDIT.9' 5) A second option is to eliminate the DDIT incentive entirely, on the grounds that few small firms are likely to use DDIT, even with a streamlined application process. Firms with less than 50 employees could be brought under the HRDF and registered; however, the issue of payroll contributions for these firms needs to be resolved. The government might consider a waiver of the payroll levy for small firms, and a block grant to the HRDF from general revenues to cover the costs of their use of training services.2' Bringing all firms under the HRDF would eliminate duplication by two agencies, and simplify administration since the inevitable growth and shrinkage of firms above or below the 50 employee cutoff would be seamlessly accommodated by universal coverage of all manufacturing firms. (The Cabinet has already decided to contribute R.M.2,000 for every R.M.1.00 to be paid to firms that opt to join the HRDF. Government's contribution will be reduced to 0.5 percent of the monthly basic wages and fixed allowances. This subsidy is to be given for five years after which it will be reviewed.) The HRDF Scheme 4.51 The HRDF was established in 1993, with a matching grant from the Government.X' The Act created a council (HRDC), with representatives from the private sector and from responsible government agencies, and a Secretariat to administer the HRDF schemes. Unlike DDIT, the HRDF is not a subsidy scheme. Employers who have contributed a minimum of six months are eligible to claim a portion of allowable training expenditures up to the limit of their total levy (1 percent of payroll) for any given year. HRDF then reimburses them for such expenses. For that purpose, the HRDC has set rates of reimbursement, varying by type of training and generally being lower for the companies with 200 or more Le This option is predicated on the assumption that onerous reporting requirements are the principal cause of the low DDIT takeup by small firms. More likely, the problem is that small firms do not find DDIT attractive because they have no income to shelter, they do not see the benefits of training, and they wish to remain unregulated. L' This could be justified on the same grounds used originally to exclude firms with less than 50 employees from the HRDF, namely, ability to pay and lacking the capacity for training, their levies used to subsidize training in larger, more training-intensive companies. ' The Government contributed R48.9 million to match projected company levies in the first year; in each of the following three years, it will add an additional R16.3 million to the HRDF. - 116 - employees (larger firms') as compared to those with less than 200 employees ('smaller firms) : (a) technical, craft, and computer training at 60 and 70 percent for larger and smaller firms, respectively; (b) quality-related training at 60 and 70 percent; (c) supervisory training at 60 and 70 percent; (d) other retraining at 40 and 50 percent; and (e) overseas training at 30 percent. 4.52 Three training schemes were introduced in July 1993--the ATP (Approved Training Program) scheme for approved training in registered training institutions, the SBL (Skim Bantuan Latihan) scheme for ad hoc inplant or external training from non-approved institutions, and the PLT (Pelan Latihan Tahunan) scheme for firms desiring training on an annual basis. In the ATP scheme, employers can send their employees for training without the prior approval of the HRDC and submit claims on completion of the course. They would select ATP approved training programs offered by training providers in the PROLUS system. In the SBL scheme, which is intended to be the main funding mechanism, prior approval of training programs must first be obtained from the HRDC. Employers submit structured training plans with specific objectives, areas of training, duration, number of trainees, instructors, and means of assessment. In the PLT scheme, which is designed to minimize the burden of multiple filings, employers submit detailed annual training plans covering at least 10 percent of the company' s workforce and 15 percent of junior level employees 4.53 Table 4.7 shows the numbers of firms registered, claims filed, and workers trained under each of the three schemes between June 1993 and March 1994. To date, a total of over 3,300 companies have registered with the HRDF. The SBL scheme had the largest number of training programs (2,010), followed by the PLT scheme (923) and the ATP scheme (615). However, in terms of numbers of workers trained, the PLT scheme was the largest, with over 56,000 trainees, followed by the SBL scheme with 52,000 trainees. Interestingly, only about 2,000 employees have been trained in ATP approved programs. This finding is consistent with evidence presented in Section B on employers' preferences for inplant training over training offered by external private training institutions, since firms can tailor training to their specific skill and technology requirements. Table 4.7: Summary Data on Operadon of the HRDF Schemes Schemes 1993 1994 0L 1. Number of Companies Registered 3,273 3t 3,304 2. ATP Schemr (approved programs) Training Programs 446 169 615 Number of trainees 1,308 761 2.069 3. SBL Scheme (ad-hoc programs) Training Programs 1.129 881 2.010 Number of tainees 23,780 28,269 52,049 4. PLT Scheme (annual plan) Training Programs - 923 923 Number of urinem - 56,206 56,206 Nte: 1993 refers to second half of 1993, and 19941 othe frst quarter of 1994. Sorce: HRDP (unpublished dtaL). - 117 - An Assessment of the HRDF 4.54 Several issues arise in evaluating the HRDF scheme. First, is the HRDF having the desired effect of encouraging companies to begin providing, or increasing provision of, more structured training for their employees? Second, are the differentiated rates of reimbursement by type of training eliciting broadly the right kinds of training? Finally, as currently structured, is the HIRDF well organized to administer and intervene in inducing increased training by employers? 4.55 The first issue, whether HRDF is encouraging more structured training for employees from companies, can only be answered with data on the incidence and level of training, and its rate of change over time. Given the relative newness of HRDF, this will not be feasible; instead, the analysis focuses on the rate of takeup of different HRDF schemes. This takeup rate can be used as a benchmark against which outcomes in future years can be compared to evaluate the impact of HRDF on increasing training. The analysis also focuses on takeup rates by firm size and sub-sectors, to identify the broad attributes of non-training firms that might be targeted for closer attention by the HRDF. The data for this analysis were created by linking files on firms using the SBL and ATP schemes, with files on all firms registered with the HRDF.L'' 4.56 On the broadest level, the data indicate that initial use of HRDF schemes has been relatively low, especially among smaller firms. Figure 4.6a shows the takeup rate of the SBL and ATP schemes by firm size as a percentage of firms registered with the HRDF. For all firms combined, the takeup rate of SBL scheme was over 12 percent, that of the ATP scheme about 14 percent. About 6 percent of companies used both schemes while about 80 of companies used neither scheme. The rate of takeup in each scheme rises dramatically with firm size, as does the takeup of both schemes. In small firms with less than 100 employees, the takeup rate for SBL and ATP is 4.3 and 6.3 percent, respectively. In the largest firm size category with over 1,000 employees, the corresponding takeup rates are much higher, about 52 and 40 percent respectively. It is important to note that even among large firms, the takeup of these HRDF schemes is not universal. Over 38 percent of large companies did not file training claims under either scheme. This firnding would be essentially unchanged even if use of the PLT scheme was considered, since no more than 24 companies have approved annual training plans. 4.57 In terms of trainees, the data (see Annex 4C) indicate that small companies are training a lower proportion of their workforce as compared to large firms. This finding is consistent with evidence presented from the 1988 survey. Companies with less than 100, 100-199, 200-1000, and 1,000 plus employees accounted for about 11, 3, 26, and 60 percent of all SBL trainees. Their share of all employees in companies registered with the HRDF was approximately 15. 16, 52, and 17 percent, respectively. Thus, relative to their share of all employees in registered firms, large firms are providing more employees with SBL training than smaller employers. A similar firm size pattern is found in the case of ATP training, though the differences by firm size are less marked. Thus, compared to larger firms, small firms are more likely not to use StRDF schemes and when they 21' The files for the PLT scheme were not available for this analysis. - 118 - do, to use them less intensively. 4.58 Like the 1988 survey, these data revealed wide variations across sub- sectors in the rate of takeup of the HRDF schemes. See Figure 4.6b. By sub- sector, the highest takeup rates of either scheme by employers are found in professional & scientific instruments, general machinery, electric machinery, and ceramics and glass; sub-sectors with low takeup rates are food, beverages & tobacco, textiles and apparel, and wood products & furniture. In terms of trainees, with 44 percent of all employees in registered companies, the electric machinery sub-sector accounted for over 80 nercent of all SBL trainees and 39 percent of all ATP trainees. In contrast, the wood products & furniture sub- sector had less than 1 percent of trainees in either scheme, even though its share of all employees aas over 7 percent. Similarly, the textile, apparel and footwear sub-sector had less than 2 percent of trainees in either scheme and a share of employment of over 4 percent. Thus, the cross-sectoral patterns of training under the SBL appears little different from that reported in the 1988 survey. Fig<.4.6a: Percent Takeup of SBL and ATP *0 40 - 30 20- .100 100- 199 200- 1000 1000. I oyfl_t Sir t SBL 4 *TP o gOph Source: Annex table 4C.3. - 119 - Fig. 4.6b: Takeup of SEL and ATP by S,ub . PtO 35 32- 35 1 2 3 4 5 5 7 9 9 10 11 12 13 S -ee -I e .tcrl I -o b. I -1 0 SL + ATP o BEth Source; Annex table 4C.3. 1 Food beverage tobacco 2 Textile apparel footwear 3 Wood products & furniture 4 Paper & publishing ' Chemicals petrol & rubber 6 Ceramics glass & minerals 7 Ferrous & metal products 8 Fabricated metals 9 Machinery 10 Electrical machinery 11 Transport equipment 12 Prof/scientific equipment 13 Other manufacturing 4.59 The second issue concerns the types of training provided by employers, and whether differential rates of reimbursement are broadly effective in shaping the mix of training. Implicitly, the current rate structure values technical, craft, computer, quality, and supervisory-related training most highly (60 or 70 percent), followed by 'other training' (40 or 50 percent), and finally overseas training (30 percent). With one year of data, the impact of the rate structure on training mix cannot be assessed; all chat can be done is to compare - 120 - the composition of training and the rate structure. Perhaps the more critical question at this point is whether the composition of the Human Resource Development Council that administers the fund and influences the training programs correctly reflects private sector preferences for training needs, especially since the firms, skill needs are so heterogeneous. 4.60 Is the distribution of training by type consistent with the reimbursement rate structure? Table 4.8 shows the numbers of ATP and SBL trainees by types of training. It distinguishes between 6 types of training-- computer, quality, supervisory, technical and craft, overseas, and 'other' training categories In both schemes, the 'other training' category is the oredominant tvoe of training done -- 56 percent of ATP trainees and 38 percent of SBL trainees--even though this training category has the lowest rate of reimbursement next to overseas training. It will be recalled that employers also placed the same emphasis on 'other' training under DDIT. This may be explained by the fact that the 'other' category is primarily for retraining and skills upgrading of production workers, who typically make up the largest occupational group in industry. The two other largest groups of ATP trainees are concentrated in supervisory (12 percent) and computer (11 percent) training. In the case of SBL trainees, the other large groups are technical & craft (28 percent) and quality-related (22 percent) training. 4.61 Are patterns of SBL training by type different across firm sizes? In the smallest firm size category under 100 employees, the overwhelming number of trainees are in technical & craft-related training. This is encouraging since smaller firms have traditionally been weakest in technical kinds of training. In contrast, companies with over 100 employees are most likely to train in the 'other' training category. Furthermore, the proportion of trainees getting computer and quality-related training rises with firm size, which is also to be expected given the greater degree of capital-intensive, computer-aided production and export-orientation of larger companies. 4.62 There are bound to be differences in skill requirements among industries as confirmed in the data on SBL takeup. This happens because of the kinds of labor hired and the types of technology and production processes used (see Annex 4C) . Compared to the sample mean, quality-related training is emphasized by fabricated metals; computer training by food and beverages; technical training by scientific instruments, and the 'other training by the transport equipment sub-sector. For SBL trainees, the technical/craft category can be further broken down into technical training--25 percent--and craft-related training--3 percent. Craft-related training under the SBL scheme is important in only 3 sub-sectors--textiles, apparel & footwear (21 percent), machinery (5 percent) , and electric machinery (3 percent) --in the other sub-sectors, virtually no SBL training is craft-related. These large differences in skill requirements by sub-sector call into question the likelihood of success, and merit, of policy intervention to shape the socially desired mix of training. - 121 - Table 4.8: Distributdon of ATP and SBL Trainees by Type of Training A7P SBL - Firm Size rrsininf 7'vveTotal Total <. <20 0 < 10 I S 00 Number Trainees 2069 54644 5923 1579 14410 32732 P^ercent Computer 10.6 6.5 1.6 3.9 5.3 8.0 Quality 2.2 21.7 6.5 9.6 13.3 28.7 Ochers 55.6 37.7 6.5 57.4 36.4 43.0 Foreign 0.0 1.0 0.5 1.9 1.2 0.9 Supervisory 12.3 5.2 2.2 16.2 8.3 3.9 Technical/craft 19.2 27.9 82.7 11.0 35.4 15.6 Note: ATP esdmates from urnpublished HRDF data; SBL estimates are taken from Annex Table 4C.4. 4.63 The final issue is whether the HRDF is well organized to administer and intervene in encouraging employers to train. Several questions arise regarding the organization and implementation of the HRDF to date. Is the HRDF Secretariat adequately staffed? Does it have analytic capabilities and ability to develop new and innovative training schemes? Can the existing schemes be implemented more effectively to minimize administrative burden and elicit greater responsiveness from the private sector? Are the three existing HRDF schemes adequate, and if not, what kinds of new programs should be developed and which groups of firms should be targeted? These questions are addressed in turn. 4.64 First, the HRDF Secretariat is under-staffed. With the exception of several senior personnel, most of the existing staff are preoccupied with either data entry or the processing of application forms for the three schemes. There is, as yet, no large capacity computer system (one is on order) and personal computers are extensively used. Several higher level professional positions are needed, especially in planning and new product development. It is critical that these positions be sanctioned and filled quickly so that new training programs can be developed, and the HRDF' s dissemination and outreach efforts expanded. In this regard, the slow pace of the public service department and low civil service salary scales are constraints on the speed with which the Secretariat is able to meet its staffing plans. 4.65 Second, there are tensions between the objectives of, on one hand, regulating abuse of the scheme and on the other, encouraging private sector participation in the HRDF schemes through a simplified application procedure. Companies and training providers have complained, individually and through industry associations, about the administrative burden of filling in application forms and of gaining approval for training programs. Transparency in the regulatory procedure must be ensured in order to prevent abuse. A more streamlined application procedure--with the minimum reporting needed for HRDF'Rs administration, monitoring, and planning, and with appropriate incentives for not cheating--would eliminate these transactions costs. 4.66 Finally, the low takeup of HRDF suggests that an expanded program of outreach and dissemination is required. In this regard, planned and ongoing initiatives of the HRDF in the following areas are critical: ia) the proposal to send companies periodic statements of their levy payments and training claiims; this should serve to inform top management about training activities in the - 122 - company, and the 'costs' of their not training. Such statements are already being sent and would be sent on a half-yearly basis; (b) the proposal to conduct group seminars on training needs analyses (TNA) at low, and fully reimbursable, costs; by targeting smaller enterprises, these workshops should provide more training in smaller firms;W (c) a proposal to develop an on-line information system about training providers and courses; and (d) HRDF financing of the training components in integrated packages of services targeting SMEs. Such an expanded program of outreach and dissemination will be required if accumulated surpluses are to be disbursed. To date, the HRDF has accumulated surpluses of about R 60 million, of which only RM25.2 million has been granted to employers for re-training and skills upgrading involving a total of 222,330 employees/workers. Some Recommendations 4.67 It is too early to make judgements about the efficacy of the HRDF in promoting training and skill upgrading. Additional years of accumulated information and experience with the different schemes will be needed to do that. The above description was intended to provide a crude benchmark against which future training outcomes can be compared. In the short-term, several measures may be taken quickly to improve the effectiveness of the HRDC Secretariat and the administration of the HRDF.'3 1) The reimbursement rate could be simulified further. The rate structure has been simplified recently and now range from 50 percent (overseas training) to 80 percent (technical and craft skills) . This needs to be simplified further to give employers greater incentives to train in critical skills and in smaller companies. However, as the analyses indicated, these differential in rates are still large and are unlikely to have much influence on training mix; employers will Z'Such workshops have begun since August 25, 1994. A total of thirty workshops were planned through the end of 1994. LI' It is critical that the HRDF be perceived early on by the private sector as a partner in skills training and not just another tax on companies. Accumulated surpluses exceeding RM60 million reinforces this latter view but also suggests the magnitude of the training challenge that faces the HRDF. - 123 - train wherever their skill needs dictate.21' One single reimbursement rate, perhaps 80 percent, would allow companies to make training choices and skills mix appropriate to their specific circumstances>2; to the extent that the reimbursement is partial, they have an incentive not to spend on 'frivolous' training. This rate structure would also simplify the application process for both employers and the HRDC, and eliminate uncertainty on the part of firms about reimbursement rates 2) tt is recommended that the HRDF be corooratized, and given greater autonomy over personnel and policy matters. The Secretariat should move quickly to fill higher level professional positions, and establish a training development unit to develop and promote new and innovative schemes for training delivery. 3) The aonlication and aonroval procedure should be streamlined wherever feasible. Recognizing that government has legitimate administrative data needs, the approval procedures could be streamlined in two areas.)' First, the current procedure of approving specific ATP courses is cumbersome and time-consuming: instead, the HRDC could focus on certifying providers under the PROLUS scheme. The operation of the market (employers and providers) would determine what training courses are demanded and who should supply them. A mechanism should also be instituted for eliciting trainee complaints and for periodic review of training providers. A second area is to grant exemptions from the payroll levy for companies with a demonstrated track record of extensive employee training,'7 which would reduce administrative costs for these companies and for the HRDC. However, there should still be reporting requirements and periodic review of companies records to monitor compliance. 2" In discussions, a training officer of a large electronics firm in Penang noted that while the ranking of critical skills implied by the reimbursement rates was generally valid, firms can vary greatly in their skill requirements and will train irrespective of the rate of reimbursement. Furthermore, the 50 percent reimbursement rate for overseas training (although an improvement over the 30 percent that existed until recently) is still low, given the importance of overseas training in technology transfer. L" The HRDC is already considering a proposal to simplify the rate structure into two levels--a lower rate for administrative-related tiaining, and a higher rate for all other training. 6/ Some minimal data are required for the HRDC to monitor trends in training, establish a benchmark against which future programs and outcomes can be evaluated, and ensure that training providers meet specific performance standards. 3" This may be phased in over several years. One criterion for levy exemption might be consistent expenditures on training in excess of 1 percent of payroll. - 124 - 4) An arrangement in which the HRDF uses certified training oroviders as 'aaents' should be given serious consideration.' This proposal has tangible benefits for all parties. In essence, training providers would charge trainees the portion of costs that is reimbursable (say 30 percent), and submit a request to the HRDF for the balance of costs (70 percent). This arrangement should appeal to both employers (no paperwork and low upfront costs) and training providers (scale economies in billing the HRDF and a marketing tool for attracting trainees). It also has several administrative benefits for the HRDC, reducing paperwork and simplifying oversight of the ATP scheme. I This proposal was well received In discussions with the HRDC and industry associations. - 125 - APPENDIX 4A Estimating the Labor Market Outcomes of Public Training 4.68 An important part of any evaluation of training providers should be analysis of the effects of training on subsequent labor market performance of graduates. In Malaysia, where there is a multiplicity of public and private training providers, this evaluation should include comparisons of the performance of graduates from the different training institutions, taking into account their unit costs of providing this training, the types of courses provided, and other factors influencing the outcomes of training that are not related to the quantity or quality of training provided. 4.69 Data useful for such an evaluation were collected by the National Vocational Training Center (NVTC) as part of its evaluation of graduates of training programs that took the trade tests administered by NVTC in 1991.2' The sample included test-takers from several public institutions including ITIs (Human Resources) , IKM (MARA), IKBM (Youth and Sports), IKK (Defense), PLK Johor, SMV (Education) , private sector training institutions, employers, and others. The survey elicited broad information on work status between six months to one year after taking the trade test, time taken to find employment, starting pay, and relevance of training to current employment. A sample of 4,091 persons with relatively complete data on key variables was used for the following analysis.. 4.70 A variety of non-linear regression models (probit and ordered probit) were used because of the categorical and ordered nature of the four labor market outcome variables: (A) probability of working (probit of working or not working), (6) time to first job (ordered probit of finding a job in less than six months, 6-12 months, or longer than 12 months) , (C) starting monthly pay (ordered probit of getting less than RM 400, RM 400-600, and more than RM 600), and (D) relevance of training (probit of training used in job or not used) . Simple linear regression models are not well suited to estimating these kinds of outcomes, since they can generate predictions outside the probability bounds. 4.71 The objective of this analysis is to compare the relative performance of graduates from different training providers in each of these outcomes, while controlling for the effects of sex of trainee; skill level attained (basic, intermediate, or advanced); trade area (automotive, building, mechanical, electric and electronic, tailoring, and draughting); and state of residence. This is important since labor market outcomes are affected not only by the characteristics of the trainees themselves (e.g., sex) , but also by factors such as their trade area (e.g., demand for technicians with mechanical, electric, or electronic skills) , or local labor market factors (e.g., states vary in stage of 2V In this tracer study, over 8,000 questionnaires were mailed out and 4,901 responses were received for a response rate of about 91 percent. The results of this survey are reported in a 1993 NVTC document, 'Laroran Kaiian Menaesan Kedudukan Bekes-Bekas Pelatih Institusi Latihan Kemahiran Awam dan Swasta Keluaran Tahun 1991 Di Dalam Pasaran Buruh. - 126 - industrialization, pay scales). The regressions yield estimates of the effect of each variable on outcomes of interest, holding constant the effects of all other included variables. 4.72 Tables 4A.l and 4A.2 report the results of these analyses. Table 4A.l considers two outcomes: (1) the probability of working, and (2) the probability of receiving one of three starting pay categories. In these regressions, the parameter estimates are compared to the following omitted groups--males, those with basic skill level, test-takers from the SMV (vocational secondary schools), those with training in the electrical and electronics trade, and those residing in Perak state. Table 4A.2 deals with two other outcome measures: (3) time to find job, and (4) relevance of training to work. These regressions do not include controls for state of residence since an expanded model specification found no statistically significant effects of state of residence on these two outcomes. Table 4A.I: ProbabDlty of Workilag & Mosthly Starting Pay Probih Ordered Probh Working (n=4091) Starring Pay(n=2309) X-variables Coef z-score Coef z-score female .145 1.18 -.400 -2.89 inter. skill .163 2.51 .360 5.27 advan. skil .215 1.18 .911 4.42 ITI .782 7.77 .687 7.69 IKM .294 4.12 .683 8.63 IKBN .434 2.66 .668 3.78 Priv. Instil. .740 5.06 1.094 9.25 IKK -.248 -1.18 .767 3.05 PLK lohor .314 1.85 -.095 -0.54 Other Inslit. .489 3.43 .658 4.34 Automotive .042 0.65 .013 0.18 Building -.161 -1.95 -.401 -3.61 Carpentry -.102 -1.28 -.607 -5.78 Mechaniical -.049 -0.88 .057 0.89 Tailoring -.237 -1.54 -.397 -2.04 Draughting .252 0.82 .756 3.17 Johor .451 5.03 .301 2.85 Kedah -.067 -0.63 -.181 -1.27 KelanLan -.603 -5.83 -.391 -2.34 .L. .447 3.97 .232 1.88 Labuan .288 0.64 -1.183 -1.70 Melaka .253 1.93 -.023 -0.16 N Sembilan .063 0.53 .038 0.24 Pahang -.076 -0.73 -.028 -0.20 Perlis -.242 -1.27 -.413 -1.35 Penang .625 5.47 .052 0.42 Sahah -.522 -4.01 .036 0.16 Sarawak -.268 -2.58 -.138 -0.96 Selangor .656 6.98 .247 2.39 Trenganu -.444 -4.12 -.175 -1.16 cult .329 na -cut2 1.524 na Constat .053 0.68 - 127 - Table 4A.2: Time to Find Job and Training Relevance To Job Ordered Probsi Probil Time to Find Job Relevance to Work X-vaniables Coef z-score Coef z-score female -.330 -1.91 .431 2.90 inler. skill 013 0.15 .236 3.15 advan. skil .128 0.51 .477 2.10 ITI -.233 -1 98 .527 5.37 IKM - 099 -1 02 .855 1000 IKBN -.078 -0 35 .776 3.84 Pnv. Instil. .447 3.37 794 5.90 IKK .321 1.14 -.334 -1.24 PLK Johor 039 0.19 .746 4.19 Other Instil. .287 1 64 .808 4.88 Automotive Ho 1 25 -.076 -0.96 Building 260 2 20 -.545 -5.01 Carpentry 042 0.36 - 550 -5.31 Mecharnical - 096 -I 23 - 061 -0 90 Tadoring -014 -0.06 -.381 -1.99 Draughting - 813 -1.73 ciltl 826 _ci12 1.710 Coastant -.094 -1.96 - 128 - APPENDIX 4B Summary Statistics on the DDIT Scheme Table 4B.1: Summarv Statistics on DDIT Approved Programs - 1988-1993 Charactenslics 1988 1989 1990 1991 1992 1993 88-93 Prograins approved 10 57 29 29 160 306 591 Programs rejected 22 78 74 8 54 86 322 Rejection rate (%) 68.7 57.8 71.8 21.6 25.2 21.9 35.3 Number of trainees 34 387 125 153 970 1,584 3.253 craftsmen 0 0 6 0 5 20 31 supervisory 5 82 25 30 95 128 365 engineer 2 120 42 16 292 316 788 technical 18 85 31 49 187 481 851 others 9 100 21 58 391 639 1,218 Cost (RI,OOOs) 298 1,916 1,241 1,714 7,442 19,856 32,466 Source: MIDA - 129 - APPENDIX 4C A Preliminary Analysis of the HRDF 4.73 The objective of this analysis is to determine the takeup of two HRDF schemes (the SBL and ATP schemes) as of March 1994, to describe the firm size and industry characteristics of companies filing claims and the principal types of training that firms are providing their employees. Data on use of annual training plans under the PLT scheme are incomplete and are not considered here. The estimates reported here are therefore necessarily incomplete. Nonetheless, since the HRDP is relatively new and experience with it limited, these analyses may be useful in identifying some early trends. 4.74 Table 4C.2 provides summary information on companies that have registered with the HRDF as of March 1994, by firm size categories and by broad sub-sectors. The first two columns show the number of companies and their percentage distributions; the third column shows their distribution in terms of numbers of employees. In the following analyses, these distributions are used as a benchmark for comparing the takeup of the two schemes, and the amounts and types of training being done by companies of different sizes and by broad sub- sectors. 4.75 Table 4C.3 shows the percent of registered companies that have filed claims under the SBL and ATP schemes, by firm size and by sub-sector. According to this table, the takeup of the SBL scheme is over 12 percent, that of the ATP scheme about 14 percent. However, almost 80 percent of registered companies have to date not filed a claim under either scheme. The takeup of both schemes rises dramatically with firm size. Among small firms with less than 100 employees, the takeup rate for SBL and ATP is 4.3 and 6.3 percent, respectively. In the largest firm size category with over 1,000 employees, the corresponding takeup rates are much higher, about 52 and 40 percent respectively, but by no means universal. By sub-sector, the highest takeup rates of both schemes are found in professional & scientific instruments, general machinery, electric machinery, and ceramics and glass; sub-sectors with low takeup rates are food, beverages & tobacco, textiles and apparel, and wood products & furniture. The third column shows the proportion of firms that train under both schemes. Larger firms, and companies in the electrical machinery and professional/scientific instruments sub-sectors, are more likely to use both schemes. - 130 - Table 4C.2: Number and DIstribution of Companies and Workers Registered with HRDF by Company Size and Industry Anribules of Conpanies Reeisiered Fimrs Workers Number % % TOTAL 3371 100.0 100.0 Comeany Size Less than 100 employees 1342 39.8 15.2 100 - 199 employees 950 28.1 16.4 200- 1300 employees 921 27.3 51.7 1000 or more employees 158 4.6 16.7 Sub-sector Food beverage tobacco 311 9.2 4.4 Textile apparel foorwear 421 12.4 11.8 Wood products & furniture 385 11.4 7.4 Paper & pubOshing 210 6.2 2.2 Chemicals petrol & rubber 701 20.8 24.7 Ceramics glass and minerals 162 4.8 1.5 Ferrous & metal products 97 2.8 0.4 Fabricated metals 221 6.5 2.3 Machinery 72 2.1 0.3 Electrical machinery 603 17.8 44.0 Tramportation equipment 114 3.4 0.8 Prof/scientific equipment 21 0.6 0.1 Other manufacturing 53 1.5 0A1 Source: HRDC, unpublished data. Table 4C.3: Percent of Companies Training Under SBL and ATP Schemes by Company Size and Industry .4nributes of Companies iBL ATp Both None Company Size loUa! 12.5 14.4 6.1 79.4 Less than 100 employees 4.3 6.3 1.6 91.0 100 - 199 employees 9.6 12.6 3.8 81.6 200- 1000 employees 20.7 23.4 11.3 67.1 1000 or more employees 51.9 40.5 31.0 38.6 Sub-sectortoLal 12.7 14.9 6.1 79.0 Food beverage tobacco 7.0 14.0 2.9 81.9 Texide appar:l footwear 5.6 5.4 1.6 90.6 Wood products & furnirtre 3.5 3.6 1.3 94.6 Paper&publishing 13.7 11.4 3.3 78.7 Chemicals prlrol & rubber 13.4 18.3 7.7 76.6 Ceramics glass and minerals 18.0 20.6 8.4 71.2 Ferrous & metal products 13.1 1S.1 5.1 76.7 Fabricated metals 12.4 17.9 7.1 77.8 Machinery 20.0 25.3 9.3 64.0 Electrical machinery 22.1 21.4 11.1 68.2 Transport equipment 16.5 20.9 9.6 72.1 Prof/scientific equipment 23.8 33.3 19.0 61.9 Other manufacturing 8.9 12.7 3.6 83.9 Source: HRDC. unpublished data. - 131 - 4.76 Table 4C.4 shows the distributions of SBL and ATP trainees across companies of different employment size and across sub-sectors. The purpose is to compare the distribution of trainees with the distribution of employees in companies registered with the HRDF. Companies with less than 100, 100-199, 200- 1000, and 1,000 plus employees accounted for about 11, 3, 26, and 60 percent of all SBL trainee; this may be compared to their share of all employees (see Table 4C.1), namely, roughly 15, 16, 52, and 17 percent, respectively. Clearly, SBL training is being provided to a higher proportion of employees in large firms as compared to small firms. A similar pattern is found in the case of ATP training, though the relative proportions by firm size are less marked. Differences in the shares of SBL and ATP trainees by sub-sector are even more striking. With 44 percent of employees in registered companies, the electric machinery sub-sector accounts for over 80 percent of all SBL trainees, and for 39 percent of ATP trainees. In the case of chemicals, petroleum and rubber sub-sector, with 25 percent of employees, their shares of SBL and ATP trainees are 6 and 22 percent, respectively Table 4C4: Number and Distribution of Trainees - SBL and ATP Schemes by Company Size and Industry Aurnrlbutes of Comasmes SBt Scheme .ITP Scheme MNuber % mber I Company Size toal 54644 100.0 2252 100.0 Less than 100 employees 5923 10.8 202 9.0 100 - 199 employees 1579 2.9 317 14.1 200- 1000 employees 14410 26.4 1083 48.1 1000 or more employees 32732 59.9 650 28.8 Sub-sector totl 54644 100.0 2252 100.0 Food beverage tobacco 598 1.1 205 9.1 Textie apparel footwcar 764 1.4 44 1.9 Wood products & fsrniture 245 0.4 25 1.1 Paper & pubishing 1276 2.3 93 4.1 Chemicals petrol & robber 3324 6.1 497 22.0 Ceramics glass and miscrals 1031 1.9 100 4.4 Ferrous & mcul products 563 1.0 74 3.3 Fabricated metal 924 1.7 115 5.1 Machinery 637 1.2 64 2 8 Electrical machinery 43787 80.1 884 39.2 Transport equipment 923 1.7 105 4.7 Prof/scientific equipment 426 0.8 18 0.8 Other manufacmruag 146 0.3 28 1.2 Source: HRDC. unpublished data. - 132 - 4.77 Table 4C.5 provides information on SBL trainees by type of training (PLT and ATP data were not available for this analysis) . The types of training include computer, quality, supervisory, technical, overseas, crafts, and other categories Most of the training done under the SBL scheme is concentrated in 'other' training (38 percent), in technical training (25 percent), and in quality-related training (22 percent); the training types that have the lowest shares of S3L trainees are overseas training (1 percent) and craft training (3 percent) . By employment size, small companies with less than 100 employees tend to concentrate on technical training (83 percent), while large companies with over 1,000 workers place the greatest emphasis on 'other' training followed by quality training. 4.78 Table 4C.6 shows the corresponding distributions of training types by sub-sector. Considerable variation in the types of training emphasized is observed across the different sub-sectors. Compared to the distribution for the whole sample, quality-related training is most emphasized by fabricated metals; craft training by textiles, apparel, and footwear; computer training by food and beverage; technical training by scientific instruments, and other training by transport equipment. Table 4C.5: Number of Workers Trained in SBL Scheme by Type of Training Finn Size TrainiianeTyse Total <100 <200 <1000 1000+ 54644 5923 1579 14410 32732 Number Trainees Computer 3532 96 62 762 2612 Crafts 1449 5 0 1424 20 QuaGly 11849 388 151 1915 9395 Others 20606 383 907 5251 14065 Foreign 526 31 30 180 285 Supervisory 2869 128 256 1199 1286 Technical 13813 4892 173 3679 5069 Perceat Computer 6.5 1.6 3.9 5.3 8.0 Crafts 2.6 0.1 0.0 9.9 0.1 Quahlty 21.7 6.5 9.6 13.3 28.7 Others 37.7 6.5 57.4 36.4 43.0 Foreign 1.0 0.5 1.9 1.2 0.9 Supervisory 5.2 2.2 16.2 8.3 3;9 Technical 25.3 82.6 11.0 25.5 15.5 Nore: Coluums sum to 100 percent. - 133 - Table 4C.6: Distribution of Types of SBL Training By Industry Sub-seclor CosD. Crau fil- Ohr Foreign Suoen Tech) Toual (100) 6.4 .26 21.7 37.7 1 0 5.3 25.3 Pood bev. & tobac. 17.9 0.0 8.0 58.9 0.3 5.2 9.7 Text & apparel 3.0 21.1 29.6 41.9 2.9 1.4 0.1 Wood & furniture 2.9 0.0 0.0 69.3 0.0 20.2 7.6 Paper & publishing 3.7 0.0 2.4 65.1 0.9 8.l 19.7 Chem. & rubber 5.2 0.1 7.1 57.7 0.8 10.5 18.5 Ceramics & glaas 3.7 0.0 24.1 46.2 1.1 20.3 4.6 Ferrous metal prod. 1.1 0.0 6.6 69.6 1.9 13.3 7.5 Fabricated metals 1.4 0.4 45.4 31.7 0.3 12.5 8.2 Macbinery 0.9 5.2 22.1 44.0 0.0 24.8 3.0 Blec. machinery 7.0 2.9 23.7 33.5 0.9 4.0 28.0 Transp. equipment 1.8 0.0 1.8 82.2 2.9 0.1 11.0 Scien. instruments 1.9 0.0 13.1 5.4 4.2 0.0 75.3 Other manufacmres 2.7 0.0 34.7 61.2 0.7 0.0 0.6 Nore: rows sum to 100 percent. - 134 - REFERFNCZS - CHAPTUR I: Asher, Mukul G., 1994. "Social Security in Malaysia and Singapore: Practices, Issues, and Reform Directions," Institute of Strategic and International Studies (ISIS) Malaysia, Kuala Lumpur. Economic Planning Unit (EPU), 1993. 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