Encouraging innovation in Malaysia - CiteSeerX

CACCI Journal, Vol. 1, 2007

Encouraging innovation in Malaysia Appropriate sources of finance Cassey Lee and Lee Chew-Ging Nottingham University, Business School University of Nottingham, Malaysia Campus

Evidence from national innovation surveys in Malaysia suggests that about 21-42 per cent of the firms surveyed are innovators. The search for an appropriate source of financing continues to be a serious problem for these firms. This problem is particularly acute among micro-enterprises and SMEs, many of which are sole-proprietorship or partnership firms and thus have limited access to the capital market. Malaysia provides support for innovation in the form of direct financial grants and various tax incentives. Existing evidence suggests that micro enterprises and SMEs tend to be the main beneficiaries of financial grants. Large firms tend to benefit more from tax incentives; while micro-enterprises and SMEs find import duty exemptions to be more useful. Overall, a large proportion of the innovating firms surveyed consider government support for innovation and technology to be important. Introduction Malaysia’s economic achievements since independence in 1957 are remarkable by any standard. The country’s per capita income increased from US$ 200 in 1960 to $ 3,400 in 2000. During this period, the Malaysian economy was transformed from an economy that was heavily dependent on exports of primary commodities (such as tin and rubber) to one that is driven primarily by the exports of manufacturing goods. Today, manufactured goods account for 31 per cent of the country’s GDP and more than 70 per cent of the country’s exports. At the initial stages of Malaysia’s industrial development during the 1960s and the 1970s, government policy on technology was oriented more towards encouraging foreign direct investment (FDI) in industries considered to be “high-technology”, such as the electronics industry. Other areas were given more priority in industrial policy, such as the development of small and medium enterprises (SMEs). Efforts to enhance the country’s science and technology (S&T) capacity took place only from the mid-1980s.1 This included public policies to improve the financing of innovation-related activities such as research and development (R&D), either directly through grants or indirectly through tax incentives. The Ministry of Science, Technology and Innovation has been carrying out national surveys on R&D and innovation since the early to the mid-1990s. This article utilizes the findings from these surveys to analyze Malaysia’s experience in financing innovation and technology. Section 2 provides a brief introduction to the national surveys on innovation in Malaysia. Section 3 discusses the sources of financing for innovation and technology. Section 4 examines the problem of financing innovation and technology. Section 5 provides an analysis of government support for financing innovation and technology. Section 6 concludes. National surveys of innovation The Ministry of Science, Technology and Innovation (MOSTI), through its agency, the Malaysian Science and Technology Information Centre (MASTIC), has been carrying out Reprinted from the “Asia Pacific Tech Monitor” May-Jun. 2006, pp. 23-28. 1


national surveys of innovation (NSI) in the Malaysian manufacturing sector on a biannual or tri-annual basis since the mid-1990s. The methodology for these surveys is based primarily on the approach adopted in the Community Innovation Surveys (CIS), conducted in Europe since the early 1990s. The first NSI survey (NSI-1) was conducted in 1995 (covering the period 1990-1994), the second (NSI-2) in 2000 (covering 1997-1999) and the latest (NSI-3) in 2002/2003 (covering the period 2000-2001). In addition to these surveys, the Malaysian Knowledge Content Survey (MyKe Survey), carried out in 2003, also covered innovation, albeit in a more limited manner. The definition of innovation that is used in these surveys comes from the OECD’s Oslo Manual as well as variations in the CIS surveys. In these surveys, two types of innovation are identified, namely, product innovation and process innovation. Their definitions are provided in Box 1 of this article. Box 1: Definitions of innovation Innovation An innovation is a new or significantly improved product (goods or service) introduced to the market or a new or significantly improved process introduced within your company. An innovation is based on the results of new technological developments, new combinations of existing technology or the utilization of other knowledge acquired by the company. New product A new product is a product whose technological characteristics or intended uses differ significantly from those of previously produced products. Improved product An improved product is an existing product whose performance has been significantly enhanced or upgraded. The innovation should be new to the company; it has not necessarily to be new to the market. It does not matter whether the innovation was developed by your enterprise or by another enterprise. Changes of a solely aesthetic nature, and purely selling of innovations wholly produced and developed by other companies shall not be included. Product innovation A product innovation is a good or service which is either new or significantly improved with respect to its fundamental characteristics, technical specifications, incorporated software or other immaterial components, intended uses, or user-friendliness. Process innovation Process innovation includes new and significantly improved production technology, and new and significantly improved methods of delivering products. The outcome should be significant with respect to the level of output, quality of products or costs of production and distribution. The innovation should be new to the company; the company has not necessarily to be the first to introduce the process. It does not matter whether the innovation was developed by the company or by another company. Purely organizational or managerial changes shall not be included

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Table 1 summarizes the incidence of innovation in all four surveys covering the period from 1990 to 2002. Overall, there appears to be significant variations in the incidence of innovation in the manufacturing sector. The percentage of firms surveyed that indicated they carried out innovation ranged from 21 to 66 per cent. Given the biased nature of sampling in NSI-1, the actual incidence of innovation is likely to fall to 21-42 per cent.2 Sources of financing for innovation Where do firms in the private sector obtain financing for innovation activities? MASTIC’s R&D surveys since 1994 provide some information. The bulk of funds for R&D in the private sector appear to come from internal or own resources (Table 2). Government has not been an important source of funding for R&D in Malaysia.

Problems in financing innovation Is financing a serious problem for firms interested in carrying out innovationrelated activities such as R&D? Evidence from the national surveys seems to indicate that innovating firms do find “lack of appropriate source of finance” as an important factor hampering innovation activities. Results from NSI-2 and NSI-3 show that more than two-thirds of innovating firms that responded to enquiries about this issue considered “lack of appropriate source of finance” as an important factor hampering innovation activities (Table 3).3

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A more detailed analysis of data from NSI-3 can further provide insight into whether innovating firms of different sizes consider financing a problem for innovation to the same degree. The following definition of firm size is adopted:4 y y y y

Micro: less than 10 employees Small: 10-49 employees Medium: 50-249 employees Large: more than 249 employees

The results are summarized in Figure 1. Generally, smaller firms tend to find financing a more serious problem for innovation compared to larger firms. All micro-sized firms consider financing to be a moderately or very important problem for financing innovation.

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Financing problems in innovation are also likely to be related to the type of ownership structure, which in turn is related to firm size. The ownership structure for small firms is more likely to be either of the sole-proprietorship type or the partnership type (Table 4). Firms with these types of ownership structure have no access to the capital market. In fact, all firms that are of the sole-proprietorship or partnership type consider financing to be a moderately or very important problem for financing innovation (Figure 2). Government support for financing innovation The fact that most firms encounter problems in financing innovation implies that there might be a role for government support. The Malaysian government has attempted to provide some support to the private sector for innovation and technology. Table 5 summarizes the funds allocated for S&T between 1996 and 2005 that can be accessed by the private sector. The funds were allocated to the following programmes:

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y Technology Acquisition Fund – which provides partial grants to firms to acquire technologies through licensing, to enhance the design and production of new and existing products and processes. y Industrial R&D Grant (IGS) – which provides grants to support the usage and adoption of existing technologies or creation of new technologies by local companies in key technology areas, such as biotechnology, advanced manufacturing, advanced materials, automotive, IT and multimedia, electronics, energy and aerospace. y MSC R&D Grant Scheme (MGS) - which provides grants to encourage research and development in multimedia products and services amongst MSC-status firms with at least 51 per cent Malaysian ownership. y Demonstrator Application Grant Scheme (DAGS) - which provides grants to projects that are accredited as “Demonstrator Applications” (DAs), i.e. projects that give opportunities for acculturation of Malaysians into ICT-based and related activities. y Commercialization of Research and Development Fund (CRDF) - which provides partial grants to qualified R&D projects to be commercialized. Aside from providing grants, the government has also introduced tax incentives to firms to encourage them to undertake R&D activities. These include: y

Investment tax allowance on the capital expenditure incurred in inhouse R&D.

y Exemption of import duty on machinery and equipment, materials, raw materials and component parts and samples used for R&D purposes. y

Double deductions for expenses incurred in approved research projects.

Table 6 summarizes the proportion of innovating firms that received government support during the 1997-1999 and 2000-2001 periods. The two most popular type of government support received by innovating firms are: y y

Duty-free importation of machinery; and Tax incentives (such as double tax deduction).

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A detailed breakdown of the data on government support by firm size (Table 7) indicates that more SME firms tend to obtain financial support than large firms. Large firms tend to benefit more from tax incentives. However, no information is available on the exact quantum of the distribution of the related financial support and tax incentives.

There is some information on the agency and type of tax incentives these firms have benefited from. The main source of financial support for SMEs appears to be SMIDEC (Small and Medium Industries Development Corporation). For tax incentives, a few SMEs have benefited from import duty exemptions. Large-sized firms tend to benefit from double tax deduction. The information (albeit limited) on taxbased incentives seems to suggest that SMEs and large firms benefit from different types of tax incentives. How effective are the different types of government support for financing innovation? Are firms satisfied with the support that is provided by the government? Table 8 summarizes from NSI-2 and NSI-3 - firms’ evaluation of government support for innovation. Generally, 54-60 per cent of the innovating firms surveyed indicated that government support for innovation is moderately or very important. This is surprising in view of the low percentage of total firms that have received government support for innovation (Table 6).

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Conclusion National surveys of innovation and R&D have been routinely carried out in Malaysia since the mid-1990s. The evidence from these surveys suggests that the proportion of innovating firms in the manufacturing sector is between 21 and 42 per cent. These surveys also suggest that innovating firms consider the finding of appropriate source of financing to be a serious problem. This problem is particularly acute amongst microenterprises and SMEs, many of which are sole-proprietorship or partnership firms, with limited access to the capital market. The government has responded to this problem by providing support in the form of direct financial grants and various tax incentives. Evidence from the national innovation surveys suggests that micro enterprises and SMEs tend to be the main beneficiaries of financial grants. For tax incentives, large firms tend to favour double tax deductions, while micro-enterprises and SMEs find import duty exemptions to be more useful. Overall, despite the low number of firms that has received fiscal and financial support from the government, a large proportion of firms surveyed regard government support for innovation and technology to be important. Notes 1. This was evident in the five-year plan document for the period 1986-1990 (Fifth Malaysia Plan). Unlike the previous five-year plans, a separate chapter was devoted to science and technology for the first time. 2. The biased sampling in NSI-1 is due to the fact that, unlike subsequent surveys, the firms selected for the surveys were selected from a list of firms performing R&D in 1992, firms that had obtained ISO 9000 certification from SIRIM, firms that claimed R&D incentives from MITI and tenants of the Technology Park Malaysia. 3. The impact of biased sampling in NSI-1 is evident here as well. 4. This is based on the European Commission’s definition. See European Commission (2005). References 1. Economic Planning Unit, Prime Minister’s Department (2005). Knowledge Content in Key Economic Sectors in Malaysia 2004, Putrajaya, Malaysia. 2. European Commission (2005). The New SME Definition: User Guide and Model Declaration. 3. Ministry of Science, Technology and the Environment, Malaysia (1996). 1994 National Survey of Innovation in Industry. Kuala Lumpur: Malaysian Science and Technology Information Centre. 4. 2000. National Survey of Innovation in Industry, 1997-1999. Kuala Lumpur: Malaysian Science and Technology Information Centre. 5. 2003. National Survey of Innovation in Industry, 2000-2001. Putrajaya: Malaysian Science and Technology Information Centre. 6. 2004. National Survey of Research and Development 2004. Putrajaya: Malaysian Science and Technology Information Centre. 7. 2004. Malaysian Science and Technology Indicators Report. Putrajaya: Malaysian Science and Technology Information Centre.

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