A look back at how Penang learned to shine through its electrical and electronics sector

Dr Francis E. Hutchinson, Senior Fellow, ISEAS-Yusof Ishak Institute, Singapore

Malaysia is a quintessential ‘Little Tiger’, one of five Southeast Asian countries—the others are Indonesia, the Philippines, Thailand, and Vietnam—that managed a transition from a predominantly agriculture-based economy to one with a vibrant manufacturing sector and a growing services sector. Once known for its spices, tin, and rubber, the country now has a diversified secondary sector comprising textiles, chemicals, steel, transport equipment, and other products. The electrical and electronics (E&E) sector has been at the centre of this structural shift, due to its employment, investment, output, and export earnings (Zainal Aznam Yusof and Bhattasali, 2008).

Much of Malaysia’s E&E manufacturing takes place in a range of locations along the peninsula's west coast, from Kedah in the north to Johor in the south. One location stands above the rest: Penang, a state of some 1,000 square kilometres and a current population of 1.8 million. From its beginnings in the 1970s carrying out low-end assembly tasks for American and Japanese semiconductor manufacturers, Penang has since established an international reputation for the testing, assembly, design, and research of semiconductors and components. Over the past five decades, the state has successfully transformed its economic model, away from trade logistics towards manufacturing.

Beyond hosting the greatest number of E&E firms and generating the majority of Malaysia’s electronics exports, research consistently finds that Penang’s manufacturing cluster has deeper capabilities and carries out more value-added operations than those elsewhere in the country (Best and Rasiah, 2003; Best, 2007; Rasiah, 2007, pp. 179–203). The state is home to a large and well-established group of semiconductor producers, arguably the most technologically demanding niche in the sector. These flagship firms carry out R&D tasks and have attracted specialized supplier firms in upstream activities such as design (Yoon, 2012, pp. 128–159). The state’s supplier base has been deepened with the emergence of local automated production equipment products as well as producers of semiconductor test systems (Yoon, 2012, pp. 128–159). These firms have attained market leadership in very specific areas such as precision engineering and automated machinery and equipment, and in some cases, such as Pentamaster Corporation, have themselves become multinational corporations (MNCs) with operations overseas.

Malaysia’s incursion into the E&E sector has been well documented, as has the role of its government in seeking to shape the industry’s emergence and subsequent trajectory (Felker, 2003, pp. 255–282; Yusuf and Nabeshima, 2009; Rasiah, 2011). However, a uniquely national-level perspective cannot explain why Penang has pulled ahead of other electronics-producing states, and why it has capabilities not found elsewhere in the country. Although Malaysia has an exceptionally strong and pervasive central government, it is a federation of 13 states and three federal territories. State governments can raise their own revenue through taxation and other means—albeit through limited sources—and spend the revenue they earn (Gray and Dunning, 2002, pp. 409–434).

Continuous research and development enhanced Penang’s E&E industry
Source: 1969 Motorola Annual Report

This article examines policies and strategies implemented by the Penang state government from 1969 to 2010 to see how measures implemented at the local level facilitated the emergence of the state’s E&E sector and its subsequent development. This period begins immediately prior to the emergence of the E&E sector in Penang and elsewhere in the country, and ends with the state’s new economic model well in place.

New Direction, 1969–1980: Lim Chong Eu and the Penang Development Corporation

Until becoming part of the Malayan Union in 1946, which evolved into the Federation of Malaya in 1948, Penang had long operated as a free trading port focused on shipping, logistics, and financial services—as a component of the British colony of the Straits Settlements which also included Singapore and Malacca. In the 1960s, and now a state within the Federation of Malaysia, Penang's economy was undercut by federal policies, such as the pursuit of import substitution and the promotion and upgrading of Port Klang (until 1972 Port Swettenham) in the state of Selangor, as the country's main feeder and container port. Penang’s per capita income declined over the 1960s and, by 1969, its unemployment rate was double the national average (Nathan Associates, 1970).

Lim Chong Eu, Second Chief Minister of Penang, 1969–1990
Source: National Archives Malaysia, Accession No: 2001/0045035W

Against this backdrop, the Alliance government, which had been in power in Penang since independence, was voted out in the 1969 state election. The victor, a newly established and multiracial political party, although mainly supported by Penang's ethnic Chinese, Gerakan, secured a majority in the state assembly. Led by Penangite and prominent politician, Lim Chong Eu, the party pledged to prioritize state-level interests and revitalize its economic fortunes.¹

Upon assuming power in Penang, Lim and other Gerakan leaders sought to acquire the institutional wherewithal to pursue their goal of economic transformation. They were reluctant to rely on the senior cadres of the state government, who were federal civil servants seconded to Penang. After initially considering the Penang City Council, Lim decided to use the newly established Penang Development Corporation (PDC) as his institutional vehicle. Modelled on Singapore’s Economic Development Bureau, the PDC (and its counterparts in other Malaysian states) were intended to catalyse local economies. The fact that they were established by enactments at the state level entailed more operational freedom.²

Established in 1969, the PDC initially enjoyed considerable freedom over staffing decisions. The first General Manager, Chet Singh, was a member of the elite Malaysian Civil Service and helmed the Corporation from its founding until 1990. Singh and Penang’s leadership sought to staff the PDC with high-performing professionals in key disciplines such as economics, statistics, urban planning, and geography. Through open recruitment processes, the PDC hired a multi-ethnic group of graduates from local universities, many of whom were from other parts of the country.

By 1974, the PDC had a core of 105 staff, growing to reach almost 330 by 1980 (PDC, 1980; Singh 2011). During PDC's initial years Lim, as the Chief Minister of Penang, also had flexibility in appointing members to its Board, who were selected to provide a variety of perspectives. This strategic input was bolstered by technical information provided by a local think tank, the Centre for Policy Research, as well as relevant federal agencies (Hutchinson, 2006).

Lim treated the PDC as the ‘first among equals’ of the state government bureaucracy, always consulting with its senior staff before beginning new projects. The consistent political backing provided to the PDC, along with its highly qualified professional staff and organizational autonomy, meant that it had structural similarities with Chalmers Johnson’s ‘pilot agency’—the Ministry of International Trade and Industry (MITI)—which was credited with planning and overseeing Japan’s rapid industrial development in the post-war period (Johnson, 1982).

Shortly after Gerakan’s victory in Penang's state election, Malaysia was shaken by the 13th May 1969 racial riots. Despite its founding as an opposition non-communal party, Gerakan recognized the imperative of securing federal government support in post-1969 Malaysia, which would be guided by the pro-Malay affirmative action New Economic Policy (NEP) of 1971. As a Chinese-majority state Gerakan accepted that the NEP would be extremely challenging. Consequently, in 1972, it joined the newly reconfigured ruling coalition, Barisan Nasional. Despite this, Gerakan's technocratic composition, strong focus on Penang, astute political leadership, and decisions taken in the first days of its administration enabled it to maintain a considerable degree of autonomy for a considerable period thereafter (Leng, 1969; Khor and Khoo, 2008).

The PDC’s operational work was greatly facilitated by a far-sighted blueprint for the state’s economic rejuvenation—the Nathan Report of 1970 which was a multiyear economic plan for Penang prepared by a US-based international consultant and commissioned by the federal government to study the state’s rising unemployment problem. The Nathan Report recommended export-oriented industrialization for Penang, contrasting with the prevailing economic model of import substitution being implemented in Malaysia. It advised leveraging the state’s existing transport infrastructure and then initially focusing on labour-intensive manufacturing before seeking to upgrade to more value-added activities (Nathan Associates, 1970).

With this an overarching vision, the PDC then proceeded to generate funds to market the state and further develop its infrastructure. Constrained by its scarcity of Malaysia's constitutionally stipulated revenue sources for state governments, such as forestry and natural resources, the PDC proceeded to mobilize resources through judicious acquisition of land and its subsequent re-sale. This provided the financial means for the PDC to pursue its policies (Hutchinson, 2006).

Inspired by measures implemented in Singapore and Hong Kong, the PDC created a network of free trade zones (FTZs) for manufacturing activities. Within these zones imports and exports could enter and leave the zones free of customs duties. Through personally lobbying Malaysia's second Prime Minister Tun Abdul Razak, Penang became the first state in the country to establish such zones. Penang’s first FTZ, Bayan Lepas, was set up in 1972, a mere three years after Singapore’s first such facility. It was to become the most prominent centre of Penang's (and Malaysia's) global E&E industry. By 1980, Penang had a network for four FTZs and four industrial parks—areas designated for industrial development designed to bring together companies that provided complementary services. Unlike FTZs, industrial parks were not normally bestowed with any specific tax exemptions and privileges.

Leveraging these new resources as well as its available labour force, which included rising female participation rates, the PDC embarked on an international marketing drive. Ably reading the evolving internationalization of manufacturing that had begun in the 1960s, the PDC targeted E&E firms based in the United States as potential investors. Once their interest was established, the PDC leveraged personal connections with federal ministries to expedite the necessary approvals and licenses. Over the course of the 1970s, Penang came to house a core of electronics firms that would grow to become household names, such as Hewlett-Packard and Intel from the the US and Hitachi from Japan, and Siemens from Germany in the coming years (Rasiah, 2001, pp. 165–190).

For its part, the Penang state government sought to create linkages between MNCs and local firms. As Penang’s Chief Minister, Lim approached local small and medium-sized enterprises (SMEs). Working with a group of firms in the metal work and fabricated metal sectors, Lim brokered contact with leading E&E producers such as Intel and encouraged them to gradually outsource tasks to these firms, thus generating linkages with the local economy. This approach proved successful, and some of these smaller firms would grow and constitute a cohort of Penang-based firms that would in turn expand abroad.

In what was to be particularly prescient strategy, the Penang government and the PDC invested their own resources in supporting the state's economic development. As stated by the PDC:

The corporation does not believe in playing a passive role in the development of the State economy through making available the necessary infrastructural facilities and services and general support. It is a declared policy of the Corporation that its role should be an active one involving actual participation in industries, through equity participation in one form or another, and that it should grow and expand with the increased resilience of the economy (1974, p. 20).

To this end, the Corporation made investments in a diverse range of new sectors. By 1980, these included RM14.2 million in 17 locally incorporated companies in sectors such as ship-building, agribusiness, furniture-making, high-glass fabrication, and electronics. These sectors were all new to Penang. While many of the start-up firms failed, others succeeded and opened up new sectors. The first electronics firm established in Penang, Penelco, was not an MNC, but fully owned by the PDC—established in 1970 to manufacture radios and transistors until its closure in 1975 (PDC, 1977).

By 1980, 25 electronics assembly firms had established operations in the state and 25,000 jobs had been created. In the manufacturing sector, 200 firms employing 56,000 workers were operating in the state’s industrial parks. Penang’s economic fortunes were transformed. Penang's share of Malaysia's manufacturing output rose spectacularly over 1970 to 1980, from 7.7 per cent to 15.7 per cent (Table 1). In 1970, the state’s per capita GDP was just slightly below that of Malaysia and manufacturing accounted for only 12.7 per cent of the state’s GDP. By 1980, its per capita GDP was 13 per cent above the national average and manufacturing generated 40 per cent of its GDP (Tables 2 and 3).

Table 1 Penang’s share of Malaysia’s manufacturing output

Source of data: EPU (1976, 1986, 1991b).

During the 1980s, the Penang state government and PDC continued to implement policies and strategies consistent with the recommendations of the Nathan Report. And although experience began to show which policies were more feasible for the state to pursue, greater organizational challenges emerged.

One of these challenges was that the federal government strengthened oversight and control of state government operations—reflecting both greater centralization of power and legitimate federal concerns about loss-making operations established or funded by state economic development corporations (SEDCs) elsewhere in the country (Puthucheary, 2011; Hutchinson, 2014a, pp. 422–442). Thus, in 1980, the federal Ministries of Finance and Public Works were given more oversight of auditing and investment decisions made by SEDCs (Singh, 2011). In 1981, the PDC and other SEDCs also lost their autonomy over hiring, promotion, and employment conditions, which were now overseen by the federal Public Services Department. Further, the federal government appointed a greater proportion of board members (Puthucheary, 2011). However, the impact of these changes was somewhat mitigated by the long tenures of senior PDC staff, which averaged 15 years (Singh, 2011).

In contrast to the initial period of experimentation in the 1970s, the 1980s saw less innovation as Penang's more successful ventures began to bear fruit. Thus, the state’s manufacturing base narrowed and specialized, with textiles and the E&E sector firmly establishing themselves. In the late 1980s, the E&E sector diversified a little with the arrival of hard disk-drive producers (McKendrick et al., 2000). While somewhat less adventurous than in the previous decade, the PDC still sought to expand and develop new industries, as well as address local market failures. Thus, the PDC made seed investments in technologically promising sectors, such as precision engineering and bio-technology.

Building on their initial contacts with MNCs established in the 1970s, the first cohort of local firms began to outsource simpler operations to other SMEs. The 1980s proved the most productive period for Penang’s local firm base, with many new operations specializing in supporting industries, such as precision engineering, plastic moulds, metal stamping, and the manufacture of automation systems (Rasiah, 2002, pp. 177–195).

The PDC also aimed to further develop the local SME base through building specialized buildings and “clustering” them to enable inter-firm learning and collaboration. It also established a small venture capital facility (PDC 1980, 1981, 1987, 1989, 1990). A small SME “clinic” was established within the PDC during the early 1980s and operated for several years. It eventually closed, but by then had compiled the first directory of local supporting firms (PDC, 1985).

Although much effort was made to develop the state’s local firm base, it was, however, not institutionalized successfully. Much of this work relied on personal connections—as opposed to being rooted in a specific organization or office—in part, owing to the thinking of that time: PDC officials thought that once a core of local firms was established, technology and production processes would disseminate from larger firms to smaller ones—and the group would collectively grow (Hutchinson, 2010).

Still, Penang reaped other benefits from its earlier proactivity. The E&E firms in the state reached a critical mass and then began to organize collectively. For example, in 1978 the 60 largest MNCs established a business association in Penang to advance their interests. In the 1980s, the association worked with the state government on issues such as crime prevention, transport, infrastructure, and labour. Similarly, local SMEs also set up organizations to share information and lobby for common goals (Hutchinson, 2009). The state government’s openness to meet and discuss issues enabled consistent dialogue and pressing issues to be addressed.

That said, while Penang was able to accrue considerable social capital with firms, it was constrained by its inability to influence education policy. Universiti Sains Malaysia (formerly Penang University) was established as Malaysia's second public university on Penang island in 1969 but, despite the state’s focus on the E&E sector, the university concentrated on the pharmaceutical industry. Its engineering school was established only in 1987—and located in the neighbouring state of Perak until 1997 when the Ministry of Education decided to transfer it back to Penang to help meet the state's growing human resources needs. Consequently, the growing E&E sector did not have access to adequate research and innovation capabilities, and many local engineering graduates were not industry-ready on graduation.

Nonetheless, during the 1980s, Penang continued to grow and prosper, benefiting from “agglomeration economies”. By 1990, it housed 500 international and local firms in its industrial parks which, in turn, employed 120,000 people. The manufacturing sector continued to expand, accounting for 47 per cent of the state’s GDP in that year, compared with just 27 per cent for Malaysia as a whole (Table 2).

Table 2 Manufacturing output as per cent of GDP

Source of data: EPU (1976, 1986, 1991b, 2003); Department of Statistics–Malaysia (2018).

Maturity, 1990–2010

In 1990, Penang’s political context changed in notable ways. First, Lim lost his state seat, ending his tenure as Penang's Chief Minister. That position was then taken by Lim’s former political secretary and fellow Gerakan member, Koh Tsu Koon. However, although a leader of the governing coalition at the state level, he was not President of Gerakan nor did he have his predecessor’s stature as one of the Malaysia’s independence leaders. In addition, Koh’s assumption of office coincided with the height of Dr Mahathir Mohamad’s tenure as President of the United Malays National Organisation (UMNO) and Barisan Nasional Chairman, which saw far greater political centralization and stronger affirmative action in policy implementation at all levels (Mauzy, 1993). Last, Gerakan’s declining electoral fortunes meant that it needed to rely on seats secured by other Barisan Nasional members—not least Mahathir’s UMNO—to secure a majority in the state assembly.

Mirroring the changes in Penang’s elected leadership, the PDC’s long-standing General Manager, Chet Singh, also resigned that year, marking the end of an unusually long and stable tenure at the head of an SEDC (Puthucheary, 2011).³ The PDC was subsequently helmed by several senior executives, but disputes over its remit and responsibilities led to it being split into two in 2004. The PDC retained its responsibilities over real estate development, and the newly established InvestPenang focused on investor liaison and marketing.

Aware of the need to update its economic model more than 20 years after the Nathan Report, the state government was keen to generate new ideas for Penang’s development. It led two state-wide consultative planning processes—the First and Second Penang Strategic Development Plans—in 1991 and 2001. Yet it lacked the resources to fund most of the proposed measures. A notable exception was the establishment in 1997 of the Socio-Economic Research Institute, a think tank tasked with looking at the key development issues facing Penang. The state government began, however, to be crowded out by a profusion of federal government agencies set up in the state during the 1990s. None of these fully subscribed to state-level planning initiatives, and instead were heavily guided by national five-year development Plans prepared by the Economic Planning Unit. And, despite Penang’s leadership in areas such as E&E, the national five-year development plans seemed to focus more attention on alternative locations, such as Kulim in neighbouring Kedah—the home state of Dr Mahathir (EPU, 1991).

As in previous decades, the Penang state government continued to invest in strategic sectors, maintaining the policy of retaining a relatively small stake in the local economy and little debt—never more than about 50 firms and approximately RM150 million in assets. As in the past, its investments served to demonstrate its commitment to a given sector and to diminish risk for subsequent investors.

While it was aware of the importance of manufacturing and the E&E sector, into the new millennium the state government began to look more towards the service sector, shifting its investment portfolio from manufacturing towards property development (including industrial parks in Indonesia and India), tourism and leisure, as well as logistics such as air cargo handling, warehousing, and information technology (PDC, 2002).

Other prioritized service sectors included healthcare and higher education. Given the mismatch in emphasis between the local public university and the needs of Penang’s growing and technology-intensive economy, the PDC also began to invest in higher education institutions that offered engineering and other needed disciplines. Indeed, in the early 2000s, there were more students studying engineering in PDC-linked tertiary learning institutions than in the local federally funded university (Hutchinson, 2006).

During the 1990s the the Penang Skills Development Centre (PSDC), founded in 1989, emerged as a ‘pocket of efficiency’ in the state. It was jointly established by the Penang state government and locally present international corporations to provide industry-relevant training to high school graduates, unemployed university graduates, and retrenched workers from the E&E sector. The state government contributed seed funding and the land, with course content and equipment decided on and contributed by the member companies. The PSDC model was seen by the federal government as an exemplar and has been rolled out to other states in Malaysia (Hutchinson, 2006; Poh and Tan, 2012).

In contrast to the 1980s, while dialogue between the state government, firms in the E&E sector, and relevant business associations was maintained, there was less outreach from state government agencies to local SMEs. Most of the dialogues with industry were held with the cohort of local firms that had been nurtured since the 1970s, rather than newer, smaller operations. One notable initiative, the Collaborative Research and Resource Centre sought to bring together MNCs, local firms, and researchers from the local university to spark ideas and form business ventures. However, this Centre was only in operation for three years before being closed due to lack of funds and a perception that its functions overlapped with some of those of the PDC (Hutchinson, 2006).

TVET training to upskill the technical workforce
Source: Penang Skills Development Centre, 2022

In the 2008 general and state elections, the Gerakan-led government was swept from power in Penang. This was part of a broad shift away from Barisan Nasional in urban and semi-urban areas across Peninsular Malaysia, By that date, the industrial transformation process unleashed in 1969 was firmly established. But Penang's economic pre-eminance was diminishing as other Malaysian states were catching up.

Nevertheless, by 2010, Penang's per capita income was still 17 per cent above the national average, it housed some 1,400 manufacturing firms that generated jobs for 200,000 people, and manufacturing contributed 46 per cent of the state’s GDP (Tables 2 and 3). The state's population had grown to 1.6 million almost double that of 1970, and its share of ethnic Chinese had fallen to 43 per cent (Table 3).

Table 3 Penang and Malaysia’s population and GDP, 1970–2010

Notes: ^a Population data for 1990 relate to the census year of 1991.
^b In nominal terms except that data for 1980 are in 1978 prices, and 1990 are in 1987 prices.

Source of data: EPU (1976, 1986, 1991b, 2003); Department of Statistics–Malaysia (2018).

Conclusion

Although the Malaysian government provided the overall institutional and policy context within which Penang’s industrialization drive took place, the state’s stellar performance up to year 2000 owed much to its own strategic policy-making and the leadership of Lim Chong Eu. Driven by its economic meltdown in the late 1960s, Penang’s new leadership mobilized all constitutionally available resources in the pursuit of economic growth through industrial transformation.

Initially using its corporate arm, the PDC, the state government built its own pilot agency along the lines of Japan's MITI to generate innovative ideas and oversee the implementation of key policies. Maximizing its autonomy, the state government used the Corporation to generate resources, develop specialized infrastructure, and market the state overseas. Relative to other locations in the country, Penang was a first mover in the E&E space in Malaysia, and until the beginning of the 21st century only slightly behind regional leaders such as Singapore and Hong Kong.

In addition, the state government took a leading role in making strategic investments in a range of new sectors. Some failed, but others grew and established themselves, enabling the state’s economy to pivot away from its declining freeport economy to sunrise industries. Despite the financial dangers implicit in relying on state government resources to catalyse new activities, risk was mitigated by a relatively small portfolio and carefully considered investments. This avoided some of the mishaps that incurred elsewhere in Malaysia. For example, Johor’s SEDC, JCorp, expanded on the back of a highly-leveraged growth strategy and was hard hit during the Asian Financial Crisis. In 1998, JCorp’s total debt reached RM 10 billion, leading to extensive liquidations and a federal government enabled debt restructuring (Hutchinson 2014c).

By relentlessly pursuing economic growth and industrial transformation, constructing links with the private sector, and investing in strategic sectors, the Penang state government showed that other state governments can also play a determining role in stewarding their own economies and even helping to shape the national economic landscape.