Good hearing and a light touch


The nexus between national government initiatives and private sector expertise is often seen as the locus where the success of many Asian countries is decided. However, economics, like politics, always has a local base. Sub-national governments, which are often given minor roles in expert analyses of national development, are therefore necessarily important play- ers in this equation. Despite the lack of financial might, a state such as Penang, can make effective use of its many local advantages.

From the successful development of Korea’s steel and shipping industries to Israel’s software cluster, and from the US’s semiconductor giants to Japan’s automobile empire, the “visible hand” of government has been involved, and due credit is now being given them.

These heroes – when sung – tend to be powerful national governments with deep pockets and strong control over trade, fiscal and monetary policy. Using mechanisms such as protection from international competition, subsidies, providing specialised infrastructure, and even imposing financial penalties for low performance, they have managed to make their private sectors competitive.

However, this is only part of the story. It does not explain why new industries emerge or establish them- selves in one part of a country and not another. The semiconductor industry in the US is associated with Silicon Valley – and not New York. Similarly, India’s booming software sector is not concentrated in Mumbai, the country’s commercial capital, but rather in the southern cities of Bangalore, Chennai and Hyderabad.

…the Penang state government is actually in a better position than the federal government to understand issues facing the private sector in its jurisdiction — and work to resolve them.

This is because various parts of a country can have different assets and local business contexts that are more suited to a specific economic activity than others. Sub-national governments have been major players as well in creating an enabling environment for business as well as undertaking proactive measures to encourage specific industries.

However, more mobile investment along with heightened competition in many sectors means that policy-makers must now not only attract investment, but also work hard to retain it. Firms that have pro-blems getting reliable suppliers, securing appropriate labour or obtaining licenses will relocate to more amenable locations – often in a neighbouring state or province.

Thus, competition between sub-national governments is also on the rise, as they strive to outdo each other by providing incentives and specialised infrastructure.

Penang and its state government

How do these issues apply to Malaysia, and what are the implications for Penang?Despite Malaysia’s formal structure as a federation, state governments do not have a great deal of revenue or responsibilities.

Fairchild Semiconductor’s lead band area in the 1970s.

In such a situation, what options does Penang have to boost its innovative potential and compete more effectively? The answer is a “great deal”. While the Penang state government may not have much financial might, it has other attributes that it can use to its advantage.

The cases of Japan, Korea and Taiwan show us that constant, up-to-date information flowing from firms to the government is vital for good policy- making1 . Without such a flow, governments are bound to push a collection of expensive “solutions” onto the private sector.

While companies would like more highways and international flight connections, the problems they face on a daily basis tend to be more mundane.

These include securing reliable and reasonably priced water and electricity, obtaining permits quickly, meeting new clients, or accessing information on market and technological trends. These issues are particularly important for smaller firms that have limited in-house capabilities and are more affected by the surrounding environment than large companies or multinational corporations.

In this case, the Penang state government is actually in a better position than the federal govern- ment to understand issues facing the private sector in its jurisdiction – and work to resolve them.

The principle of subsidiarity argues that govern- ment institutions that are closer to their constituents are better-placed to deliver specific types of services, particularly those that provide localised benefits. This is because the level of government closest to the end-users will have more information on their needs2 . Good information can therefore enable initiatives to be carefully targeted, maximising scarce resources.

Another vital aspect of policy-making is the ability to implement measures effectively and quickly. The Penang state government has had a good track record in this area. If it can leverage these attributes again, it will be in a key position to steer the state’s economy, and move more quickly. Windows of opportunity to move into promising niches do not stay open indefinitely.

The last key ingredient is the ability for policy- making to evolve in line with industry requirements. Policy approaches that proved successful yesterday may not be the most effective today. Research in countries such as Ireland, India, Israel, Taiwan and the US shows that policies to help an industrial cluster emerge are different from those required to make it grow3 . This requires a commitment to questioning established policy frameworks, as well as readiness to restructure and – when necessary – discard. The relatively modest amounts of money that are invested at the state level also mean that there is less incentive for interest groups to lobby to “lock in” specific policies.

Despite the limited formal role for states permitted by Malaysia’s federal system, what is of importance is the effectiveness of a given policy –rather than where it comes from. Lessons from other countries and regions show us that good policies often come from “second-best” institutions, rather than those that are formally responsible for a specific issue. It is about what works in a given context, rather than what “ought” to be4 . It is therefore better to have a good, targeted policy from a small player like a state government than a wide-ranging, but ineffective measure from a well-funded ministry.

Limited power, then, does not mean zero influence. While the Penang state government is in a good position to gather information on key issues and act on many of them, what are the sorts of policies it can consider?

We can look to two sources of inspiration for appropriate measures. The first is Penang’s past, and its period of dynamic policy-making in the wake of the economic depression of the late 1960s. The second is the present, and includes lessons learned from other state and provincial governments in the region and beyond.

Drawing inspiration from the past

The late 1960s marked a turning point for Penang’s political and economic context. Rising protectionism in the region, the concentration of economic activity in Kuala Lumpur, and the revocation of the state’s free-port status led to a deep recession. By 1969, unemployment had reached 15% and income levels were 10% below the national average.

A woman operator at Advanced Micro Devices in the 1970s.

In the 1969 elections, the Gerakan party was elected to head Penang on a platform to revitalise the economy.

The next 21 years were to see a period of remarkable dynamism and innovation, as the state government under Chief Minister Lim Chong Eu moved proactively to diversify Penang’s economy.

Some key lessons that can be drawn from this period are as follows:

Develop a long-term vision

In 1970, a team of external consultants drafted the Nathan Report, which analysed the opportunities and challenges facing Penang’s economy. The Report recommended leveraging the state’s infrastructure to promote tourism and export-oriented manufactu-ring in order to diversify the economy and reduce unemployment. While approaches may have varied over time, the Nathan Report was used as the operational framework for the next two decades – which helped target policies and reduce dispersion.

Target strategic sectors for today and tomorrow

Although the Nathan Report advocated fostering manufacturing, it was the Penang state government that targeted the electronics sector. Based on developments in Japan and Hong Kong, the state government saw that this industry had three attractive characteristics – its labour-intensive nature would soak up large numbers of unemployed workers; it had the potential for increasing technological potential and value-added; and, unlike heavier industries, was compatible with tourism. This choice has proven to be correct, as while the electronics sector is very competitive, it is also very dynamic and provides many niches for an aspiring state or province.

Acquire or develop a capable lead agency

Dave Packard and Bill Hewlett of Hewlett -Packard visiting Penang’s hp facility (now Agilent Technologies) in 1974, with Chief Minister Lim Chong Eu (centre).

Lim Chong Eu appropriated the newly-created Penang Development Corporation (PDC) as an institutional vehicle to implement his policies. Its status as a statutory body initially allowed the state government considerable flexibility with regard to personnel. Thus, the Chief Minister hand- picked many of the Corporation’s staff , including a significant number from outside Penang. Of key importance was Chet Singh, an economist from the elite Malaysian Civil Service, who served as the PDC’s first general manager. While pay levels were a problem, the otherwise good working environment resulted in good staff retention – with an average tenure of 17 years. Th e PDC was thus a pilot agency with the capacity to think innovatively, move aggressively, and implement effectively – an ingredient that was also key in Japan’s economic transformation5 .

Ensure good communication

To ensure good flows of information and “buy-in” from other levels of government and departments, the PDC’s board had members from the federal, state, and local governments. In addition, good links with the local university allowed access to technical input on agricultural and industrial policy issues. And, perhaps most importantly, the Chief Minister personally brokered sub-contracting relationships between local firm owners and multinational corporations. Thus, information flowed between the state government, Penang-owned firms and international investors, creating trust or “social capital” and facilitating inter-firm relationships – an element found in successful firm clusters in Germany, Japan, and Italy6.


The PDC established a variety of enterprises in new sectors. In the first 10 years, this included: mushroom farming; furniture making; textile manufacture; ship-building; electronics; and high- quality glass-fabrication. These investments served to diversify the state’s economic base and attract investments to a new area by reducing risk. Many of these ventures did not succeed. However, many of Penang’s new industries also came from this period of experimentation. The importance attached to reducing risk for new activities was very visionary, as it is only now being established as best practice7 .

The effect of these policies over the next two decades was no less than a dramatic turnaround in the state’s economic structure and performance. By 1990, the state had a per capita income 20% above the national average, and its manufacturing sector had expanded from 2,400 people in 15 factories to 120,000 people in 500 factories. While macroeconomic stability and, thus, federal government policy played a part in this success, state government initiative was responsible in no small part for Penang’s industrialisation.

Looking elsewhere

Decentralisation and liberalisation measures enacted over the last two decades in many countries throughout the world have meant that more now than ever before, state, provincial and local governments are taking charge or being entrusted with managing their own economies. State governments in India now draw up their own plans for economic development, negotiate loans with international financial institutions like the World Bank, and establish their own highly-specialised research institutes in partnership with industry. Provincial leaders in China are playing key roles in fostering economic activity within their territories, receiving incentive payments from the central government in return for good performance.

What, then, can we learn from other experiences?

“Software” is as important as “hardware”

The Penang port.

In a rush to attract investment, it is all too easy to focus on financial incentives as well as hardware such as roads, air and sea access, and utilities. However, while these items are necessary to “open shop”, they are hardly sufficient – as governments elsewhere are also offering similar “packages”. Offering investors a location with a well-developed base of supplier firms, opportunities for the exchange of ideas and production techniques, and public facilities to support research and innovation is a competitive advantage rooted in a particular location, and is thus much harder for other regions to replicate8 .

Work with what you have

Carving out a value-added niche in an existing industry is very challenging. This is because nurturing a base of capable and innovative firms takes a long time, and requires a lot of piecemeal measures to build trust and an environment conducive to collaboration. In addition, externally-oriented sectors are exposed to the upswings and downturns of the international market. However, while it makes sense for policy-makers to seek to diversify the economy (and promote less demanding activities), it is actually easier to work with existing industries than seek to create or spark entirely new ones. So, attempts to break into new sectors should be encouraged – but not at the price of neglecting the pursuit of excellence in existing industries.

Avoid “narrow” clustering

A more viable way of diversifying is to promote a related group of activities within the same sector. This maximises the applicability of existing supporting industries, skill sets and firm relationships, yet provides a measure of protection from downturns. In addition, the potential for cross-over of ideas is greatest between firms that work in related industries as opposed to completely unrelated activities9 . However, just because firms are located in the same place doesn’t mean that they will communicate or learn from each other – hence the need for an “honest broker” such as a public body to promote communication and interaction10.

Ensure that brains “circulate”

While it is a truism to state that univer- sities should collaborate with industry, it is actually quite difficult to make happen. The need for universities to focus on basic as opposed to applied research and the desire of firms to work with readily- commercialisable products are often barriers to collaboration. However, these are not insurmountable. The work of Frederick Terman, Dean of Electronic Engineering of Stanford University is such an example. He is credited with providing Silicon Valley’s “soft ” infrastructure through pioneering an open-learning system for professionals to pursue postgraduate degrees; persuading firms to pay for access to ideas and projects being carried out by his students; and encouraging his students to start their own companies – even funding promising ventures himself. Two of his students, William Hewlett and David Packard, in turn cultivated a generation of spin-offs from their company11.

With regard to Penang, its federally- funded university as well as its growing number of private colleges is part of the equation. Making them communicate with fi rms and potential entrepreneurs is the missing factor.

To conclude

While today’s heightened level of competition can be disheartening for policy-makers, it also entails a more important and dynamic role for state and provincial governments. While large- scale infrastructure projects sponsored by national governments capture much attention, the piecemeal, long- term and small measures that make an environment conducive to growth are equally important and often overlooked. Gathering this information – and acting on it – cannot be done by bureaucrats in far-off offices, but by people close to the action who have good hearing, patience and a light touch. Innovative local economies are built one conversation at a time.

Johnson, c., 1982. miti and the Japanese Miracle: The Growth of Industrial Policy, 1925–75, Stanford University Press, Stanford. Amsden, a., 1989. Asia’s Next Giant: South Korea and Late Industrialization, Oxford University Press, New York. Wade, r., 1990. Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization, Princeton University Press, Princeton, New Jersey.
2 Abelson, p. 2003. Public Economics: Principles and Practice, Applied Economics, Canberra.
3 Bresnahan, Timothy, Anthony Gambardella, and Annalee Saxenian. “‘Old Economy’ Inputs for ‘New Economy’ Outcomes: Cluster Formation in the New Silicon Valleys”, Industrial and Corporate Change, vol. 10, no. 4 (2001): 835–859.
4 Rodrik, d. 2008. “Second- Best Institutions”, nber Working Paper Series, no. 14050, National Bureau of Economic Research, Cambridge, MA.
5 Johnson, c., 1982. miti and the Japanese Miracle: The Growth of Industrial Policy, 1925– 75, Stanford University Press, Stanford.
6 Humphrey, j. and Schmitz, h. 1998. “Trust and Inter-firm Relations in Developing and Transition Economies”, Journal of Development Studies 34.4:32–61.
7 Rodrik, d. 2004. Industrial Policy for the Twenty-First Century, Faculty Research Working Paper rwp04–047, jfk School of Government, Harvard University, Cambridge ma.
8 Gray, h. Peter and Dunning, j.h., 2002, “Towards a Theory of Regional Policy”, in Regions, Globalization, and the Knowledge-Based Economic”, in j.h. Dunning, Oxford University Press, Oxford.
9 Yusuf s. 2008. “Can Clusters be Made to Order?” in Yusuf, s. Nabeshima, k. and Yamashita Shoichi, Growing Industrial Clusters in Asia: Serendipity and Science, World Bank, Washington d.c.
10 Giuliani, Elisa and Martin Bell. 2008. “Industrial Clusters and the Evolution of their Knowledge Networks: Revisiting a Chilean Case”. spru Electronic Working Paper Series no. 171. Brighton: Science Policy Research Unit, University of Sussex.
11 Saxenian a., 1995, “Creating a Twentieth Century Technical Community: Frederick Terman’s Silicon Valley”, Inventor and Innovative Society Conference, Smithsonian Institution, November 10–11, Washington d.c.

Francis E. Hutchinson is a visiting research fellow at the Institute of Southeast Asian Studies in Singapore.

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