Malaysia is only second to Singapore (and Brunei, of course) in terms of its openness in the region, both in terms of trade as well as investment. As Malaysia is an open economy, it is essential for us to consider Malaysia in the context of the world as well as the regional economies. Hence, it is necessary to begin with some remarks about international economic prospects.

It is important for us to recognise how difficult and unpredictable the world economic situation is. Both Europe and Japan are relatively moribund at this point, and prospects for sustained US economic recovery are uncertain despite the rather strong recovery towards the end of 2003. After some initial job creation, there is renewed talk of 'jobless growth' and even a 'job-loss' recovery.

Most importantly, the US recovery is riding on the back of twin deficits. The US trade deficit, in particular, is largely related to trade surpluses in the East Asian region. The US fiscal deficit has been financed by US Treasury bonds. A vast and growing majority of such Treasury bonds have been bought by governments in this part of the world. East Asian reserves come to about US$1.4 trillion, mostly held in US Treasury bonds.

Most problematic about the current situation is the fact that the three different advanced industrial regions all see recovery as predicated on devaluation of their own currencies. Hence, what is likely to happen is a situation of competitive devaluations, leading to a 'beggar-thy-neighbour' situation, which can be unstable, even chaotic.

An inability to co-ordinate these devaluations is likely to result in greater currency volatility and monetary instability at the global level. There have already been calls, of course, for another 'Plaza Accord' to 'co-ordinate' US dollar devaluation, as happened after the September 1985 meeting at the Plaza Hotel in New York.

Devaluation offers a false solution to these problems. There have been two previous episodes of devaluation by relatively strong Republican presidents. In 1971, US President Richard Nixon destroyed the Bretton Woods system. At the beginning of his second term in 1985, another American president, Ronald Reagan, also attempted to solve US problems by devaluing the greenback at the Plaza Accord.

But the current situation is even more likely to lead to a great diversion of investible resources for currency speculation, which will only exacerbate, rather than ameliorate international economic volatility.

New tensions

At the regional level, the Bangkok meeting late last year reminded us once again that the Asia-Pacific Economic Co-operation (Apec) has been effectively hijacked by the US for its war against its enemies, not just the one against terror. Despite its name, Apec runs the risk of becoming like Asean during its first 25 years.

At its inception in 1967, Asean was established to enhance economic and cultural co-operation. But for the first 25 years, there was little economic, and even less cultural co-operation. Most Asean co-operation was devoted to political and strategic matters.

It is likely now that this will be the new future of Apec, which will further undermine the likelihood of Apec becoming a forum for effective economic co-ordination around the Pacific Rim. This poses serious problems in attempting to deal with the real problems which exist, particularly between the East Asian region and the US.

In the Asean region, there is a strong likelihood of further trade liberalisation with a bipolar pattern emerging and Bangkok becoming the hub for what might be called the Indochinese belt, stretching from Myanmar to Vietnam, and a southern pole emerging around Singapore, with the Philippines continuing to be marginalised, and perhaps developing relations with the rest of the East Asian region rather independently.

If this pattern does emerge, it will introduce new tensions into Asean and Afta, which will not necessarily be resolved by current initiatives, such as the effort to integrate Asean with China.

China-Asean economic co-operation is currently being discussed in terms of a free trade agreement. It is not clear that this would necessarily be in the long-term interest of Asean despite some possible short-term gains.

Asean is already finding it extremely difficult to prevent de-industrialisation in the face of the tremendous manufacturing dynamism of China. Recent studies suggest considerable overlap in the output profiles of the two sides, and considerable lack of competitiveness on the part of Asean in relation to China.

The likelihood of a free trade arrangement being mutually beneficial in the medium and long-term is therefore dubious at best. It might lead to de-industrialisation in Aaean, which will primarily adversely affect Thailand, Malaysia and Indonesia, and may further undermine agricultural production throughout the region.

In the short term, however, there is a great deal of attraction in further integrating with China, precisely because it is growing so rapidly, and there is fast growing demand, particularly for raw materials from the region. Malaysia, for example, has significantly expanded its palm oil exports to China, but as suggested earlier, the likelihood of further integration is probably going to exacerbate the recent problem of declining foreign direct investments into the Asean region.

There has been a reduction in global foreign direct investment (FDI) since the late 1990s, as well as greater flows to China as the favourite destination for foreign direct investment in the East Asian region.

These FDI trends are particularly worrying and problematic because next to Singapore, Malaysia has historically been the most dependent on FDI for providing momentum, particularly industrial dynamism.

Other attempts at East Asian economic integration, such as Asean+3, are unlikely to bear fruit, particularly since its most active proponent, former Malaysian premier Dr Mahathir Mohamad, is no longer in office. There is little prospect of the needed momentum being created, let alone sustained.

To add to that, relations between Japan and China are unlikely to be resolved in a fashion which will further East Asian economic integration, particularly since the Koizumi government has little commitment of this type.

Furthermore, I would suggest that the current focus on free trade agreements, as the only possible form of economic co-operation, is going to further limit the likelihood of economic integration developing at the regional level.

Economic prognosis

Let me now make explicit a couple of political assumptions about my economic prognosis for Malaysia.

One might expect two things of Prime Minister Abdullah Ahmad Badawi's administration. First, a carefully managed (insulated) revival of ethno-populism in Malaysia, particularly to try to win back the Malay vote in the run-up to the imminent general election.

At the international level, one can expect a normalisation after the heady, but clearly 'exceptional' Mahathir years. In other words, Malaysia will be much less of a maverick at the international level than it was during the Mahathir administration, particularly during its last half decade.

Given the line-up of the early January 2004 cabinet reshuffle, it seems that the line of succession has been clearly established, which further limits the options available to Abdullah in dealing with rivals within his own party. Preserving the Mahathir cabinet status quo might strengthen the party in facing the forthcoming elections. However, this would weaken Abdullah in dealing with rivalry within his own party, including challenges to his leadership, and may well reinforce the impression that he is merely warming the seat for his successor.

After early elections, many would expect to see much more business as usual, particularly at the international level, as the great expectations from the first two months of Abdullah giving way to status quo preservation.

Mahathir's efforts to try to re-stimulate domestic demand in Malaysia have had mixed results. Much therefore continues to depend on external demand. But, as suggested earlier, there is a problem of the sustainability of external demand, given the bleak prospects for the world economy, particularly in the three engines of the industrial world, given the neo-liberal economic straight-jacket preventing the utilisation of Keynesian tools to increase effective demand with counter-cyclical budgetary deficits.

The immediate prospects for petroleum and palm oil prices remain reasonably good. It is unlikely that there will be an immediate resolution, in the short term, of the problem of stabilising petroleum output and prices. Much of the petroleum being discovered and exploited in Africa and other parts of the world will not come on stream for some time to come. And palm oil output, although increasing significantly in Indonesia, will continue to enjoy growing external demand, particularly from China and India, and is unlikely to be undermined by soybean or other vegetable oils for various reasons.

De-industrialisation in Malaysia continues with factories relocating elsewhere, particularly to China, but also to other parts of the world such as Costa Rica. It is unlikely that electronics will continue to play the role in Malaysia that it has played over the previous three decades. Insofar as electronics has defined much of its industrialisation in the past, Malaysia will de-industrialise with the decline of electronics in the medium-term. This trend has already been anticipated by the government's recent promotion of tourism, education, health and financial services.

Extremely important for Malaysia in recent years has been the greater role of tourism, which of course had a setback with the Sars scare in mid-2003. There is a great deal of potential for Malaysia, not only with East Asian tourism continuing to grow. Post-9/11, there has been tremendous interest in Malaysia as an alternative destination for Muslims who feel increasingly uncomfortable and unwelcome elsewhere, especially in the West. The Malaysian authorities have a rather broad notion of tourism extending to education and tourism, including cosmetic surgery and other such health procedures.

The problems

What are some of the problems? The new regime will have to deal with albatrosses inherited from the past. One big problem Mahathir has bequeathed to Abdullah in the next few months is the second Proton plant, which will have an annual capacity of 500,000 cars, which is basically what Rayong is producing on the eastern seaboard in Thailand.

This may generate intense rivalry between Malaysia and Thailand, and it is unlikely that this matter will be easily resolved, given the contracting demand for automobiles and the continued protection of automobile markets, although the Abdullah regime will try to resolve this problem in innovative ways.

Besides Proton City, the Bakun Dam will be completed in the near future, generating far more electricity than there is demand for. The dam has lost its single largest client, the Dubai Aluminium (Dubal) bauxite plant. It is likely that Dubal will relocate its plant in China, the single largest source of new demand for aluminium.

Most of the tremendous public resources deployed for corporate and bank bailouts over the last few years will slowly trickle back, but that will not overcome the fiscal constraints the Malaysian government continues to face. More disappointingly, the crony firms which have been bailed out will not provide much basis for new growth. Despite decades of foreign-led industrialisation, there are few internationally competitive Malaysian manufacturing firms, except in palm oil refining and so on, which have emerged in Malaysia. Such internationally competitive firms were not bailed out by Danaharta, Danamodal and the CDRC in recent years

. To its credit, the double-tracking contracts with Indian and Chinese contractors, reversed in favour of Malaysian contractors, was boldly rescinded by the Abdullah government at the end of 2003, giving it more fiscal leeway than it had previously been allowed by Mahathir.

In this respect, the cancellation of the double-tracking project allows a greater degree of latitude for the Abdullah government besides signalling that 'cronyism as usual' has been put on notice. The cabinet reshuffle sent a similar hint, but the absence of any firings was most disappointing to those hoping for unambiguous messages.

Cronyism and associated rents have long existed in many parts of the world and has actually facilitated capital accumulation, growth and industrialisation in Japan and Korea for instance. But cronyism in Malaysia has involved little more than patron-client relations, money politics and political business. No captains of industry to speak have emerged after several decades. Instead, a bunch of cronies accumulated handsomely for themselves and their political patrons, but have not significantly contributed to generating internationally competitive enterprises and to economic dynamism and growth.

Finally, the emphasis in recent years on domestic-led economic growth previously involved giving out 'jobs for the boys', basically construction contracts for infrastructure. In contrast, the new budget stimulus package introduced in the second quarter of 2003 tried to stimulate agriculture as well as small and medium enterprises.

The recent appointment of Muhyiddin Yassin as minister of agriculture suggests great expectations for agriculture in the future, or his consignment to a 'dead-end' sunset sector.

However, throwing money at agriculture and at small and medium enterprises may not provide the new engines of growth desperately needed by the Malaysian economy, as past experiences suggest.

KS JOMO is a professor in the Faculty of Economics and Administration, University of Malaya. The above is part of a paper he presented at the 2004 Regional Outlook Forum in Singapore on Jan 7.