Proton
The automobile industry offers strong backward linkages with key heavy industries and manufacturing sectors, and is as such often a central part of industrialization strategies in developing countries. However, in order to move beyond the basic assembly of imported vehicles, the domestic firm will need to acquire the necessary technology to develop indigenous design and manufacturing capabilities. This task is challenging in itself but is made even more difficult in the context of late industrialization where the latecomer will be constrained by its initial inefficiency until learning takes place. Domestic firms will also find it difficult to meet the substantial capital requirements for both technology acquisition and scale economies in a mature industry.
It is for these reasons that countries attempting to industrialize will need to subsidize domestic firms for learning and eventual ‘catching up’. Technology acquisition is thus key to the development of a competitive domestic auto industry, but this can only take place if subsidies promote learning.
As subsidies potentially dilute incentives, these must be conditional on performance targets being met if learning and associated efficiency gains are to take place. The success of the technology acquisition process will therefore depend on the management of any explicit or implicit subsidy programme, in particular, the state’s institutional capacity to design the appropriate incen- tive structures, and especially its political capacity to enforce conditionalities, including withdrawing subsidies if necessary. However, state support, in the form of learning rents and other subsidies, may not be enough to encourage a domestic industry given the capital requirements and risks involved, especially in the early stages, and limited entrepreneurial capacity. Domestic capitalists may be unavailable or simply unable or unwilling to invest, in which case the state may have to undertake the initial investment. In this case, incentives are further diluted due to the separation of residual control (own- ership) from residual income (profits) which characterizes state-owned enterprises (SOEs).
Proton, Malaysia’s national car project, was launched in 1983 as part of a state-led heavy industries programme to rationalize the car industry, pro- mote industrialization through backward linkages, and meet ethnic redistributive objectives. As an infant industry, Proton’s immediate challenge
was technology acquisition necessary to develop design and production capabilities in order to produce a Malaysian car. To facilitate this process, Proton was provided with significant learning rents in the form of tax breaks for R&D, and tariff and import duty exemptions. Despite this, technological progress was slow and the company remained uncompetitive and dependent on protection. Proton’s privatization in 1995 can thus be seen in terms of government attempts to increase efficiency by improving the technology acquisition process. Privatization was also consistent with government efforts to promote capital accumulation and create Malay industrialists.
This raises two key issues. If technology acquisition requires an effective rent-management strategy in this sector, then success is dependent on whether enforcement of conditionality is easier or more difficult with private ownership. Improvements from privatization can be said to come from changes in the management and regulatory structure. Privatization may provide a more tractable management structure by reducing the owner–
manager–worker chain of command, thereby improving the owner’s incen- tives (e.g. see Alchian and Demsetz 1972). It also provides an opportunity to change the state–enterprise relationship through a more effective regulatory structure. By creating an arm’s length relationship between the government and the enterprise, privatization offers the potential for more credible sanctions and hence, a more effective regulatory structure by ensuring that subsidies are only temporary and contingent upon meeting performance targets.
However, these potential benefits may not be likely where political con- siderations determine the choice of candidate, and where the national sig- nificance of the enterprise will mean the state has a continued vested interest.
It is indeed very likely that these two factors will be related, with the choice of candidate politically determined precisely because of the enterprise’s importance. Secondly, even if privatization improved the government’s enforcement capacity, commercial viability would still depend on the private owner’s financial capacity to meet and sustain the substantial capital invest- ment requirements for technology acquisition and large-scale production.
This is an even more difficult task in the context of a mature industry charac- terized by low growth, overcapacity, industry consolidation and high entry barriers.
Proton’s privatization was characterized by ex ante and ex post state failures. While privatization may have been ‘desirable’ (in terms of industrial- ization), it was arguably not ‘feasible’ (in terms of potential profitability and attractiveness to the private sector) given the high capital costs, technological challenges and industry trends. Government requirements relating to local content and Malay participation further affected Proton’s competitiveness.
These factors would have undermined private incentives, and the case for privatizing Proton was weak, offering only a second-best solution in terms of addressing long-term technological problems. One possible explanation for privatization then is that it offered the opportunity to earn short-term profits
through a protected domestic market (along with long-term profits through improved technology and international competitiveness). Here, failure can be blamed on the government’s decision to proceed with the privatization with- out a clear understanding of the global conditions and industry challenges, including the financial resources and time required for technology acquisi- tion, and without designing a viable subsidization strategy with a clear time frame for protection. This was compounded by earlier state failure to secure technology transfer from Proton’s Japanese partner and ensure that the pro- ject was commercially viable. This ex ante failure on the government’s part appeared to have been due to leadership mistakes in approving the project in the first place, and later believing it was still viable in spite of industry trends.
However, the issue is less about whether Proton was viable to begin with but whether privatization accelerated the technology acquisition process which was key to developing a more competitive product to capture market share and facilitate economies of scale. Here, privatization was not even able to provide a second-best outcome (e.g. in terms of Proton’s own modest targets) because of the government’s ex post failure. The government did not have a long-term plan for the reduction and eventual removal of tariff and import duty exemptions to accelerate the process of technology upgrading, and there was no performance-related conditionality or attempt to with- draw rents. As discussed in Chapter 3, this has been a historical problem in Malaysia, in part related to ethnic and political considerations. In Proton’s case, the government’s disciplinary capacity was also constrained by specific aspects of patron–client relationships between the company and the political leadership due to the Prime Minister’s continued personal interest in the development of a flagship auto manufacturing sector in Malaysia that gave the company national importance. This political commitment created a moral hazard and meant that privatization did not change the fundamental weaknesses in the institutional relationship between the government and enterprise.
To complicate matters, ex ante and ex post decisions were also adversely affected by ethnic considerations. The desire to promote Malay participation in the auto industry undermined proper project evaluation and, later, Pro- ton’s competitiveness, most notably through its local Vendor Development Programme (VDP) which required Proton to source components from (inefficient) Malay vendors. Proton’s inefficiency arose from insufficient economies of scale. This was the result of a small domestic market, limited production capacity and limited exports. The inability to achieve economies of scale was due to technology transfer problems which compromised product design and production scale, as well as poor marketing and distri- bution, particularly overseas. Despite management efforts, both capacity expansion and technology acquisition involved substantially more capital and time than the new owner could afford, and which the government did not fully account for when it initiated the project or when it decided to privatize.
However, the timing of the decision to sell Proton back to the government
(when Proton’s domestic market share was declining, and with industry liberalization approaching), and the owner’s subsequent diversification into other non-competitive sectors, suggests that the owner was unwilling to undertake the necessary capital investment and may have been attracted to Proton because of the rents from car sales in a protected domestic market.
This preference was consistent with the general preference of Malaysian capital for captive rents in non-competitive sectors, as discussed in Chapter 3, and underlies the difficulties the government faced in attempting to create a dynamic capitalist class. While Proton subsequently developed its own body design and engine, and rationalized its local content programme and dist- ribution, this occurred only after it was renationalized. Crucially, product design remained poor and uncompetitive as Proton was unable to develop the necessary technology. This again illustrates the inherent technological challenges in the industry, and the viability problems of the project, not to mention privatization. More critically, it underlines the importance of the state’s disciplinary capacity in the management of necessary subsidies (in this case, learning rents) as the most important condition for successful privatization.
This chapter is structured as follows. The next section will discuss the challenges faced by the auto industry and Proton specifically. This is followed by the background to Proton’s creation, privatization and renationalization.
We then evaluate the performance of Proton before and after privatization, looking at its financial performance, production capacity, export and pro- tection levels, technology acquisition, local content, and marketing and dis- tribution. The following section identifies the main problems and causes of failure, and prioritizes the main conditions necessary for successful privatiza- tion. The final section summarizes the main findings and concludes.
Challenges
Competitiveness in the auto industry is largely a function of economies of scale and productivity. The capacity to sell vehicles also depends on final product quality and marketing and distribution. The level of technology will determine the quality of product design and the efficiency of the production process. Marketing and distribution are also important as achieving economies of scale requires selling cars. Here, Proton faced industry-related challenges as well as challenges specific to late industrializers, along with constrains posed by wider government objectives.
Industry characteristics and trends
The auto industry is characterized by requirements for substantial scale economies and capital investment, as well as increasing concentration, overcapacity and low margins. Industry data, particularly in the 1970s (when feasibility studies for Malaysia’s national car project were being conducted)
provides some context in which to assess challenges faced by the car industry.
Estimates of economies of scale in annual passenger car production ranged from 100,000 cars per year (1959) to 600,000 (1972), with a minimum of 800,000 units for long-term viability (in the 1970s), and fairly constant returns at 700,000–1.5 million units (Maxcy and Silvertson 1959; Rhys 1972;
White 1971, all cited in Bloomfield 1978). Economies of scale for engines in 1971 were around 400,000–500,000 per year, with final assembly at 200,000–
300,000 units per year (Pratten 1971, cited in Bloomfield 1978). The collapse of the British auto industry in the 1990s can be traced back to the competitive disadvantage of many UK firms by 1975 because of the failure to achieve the necessary economies of scale (Central Policy Review Staff 1975, cited in Bloomfield 1978: 85–86). The high-volume and increasingly capital-intensive nature of the industry also required high levels of capacity utilization for economic and profitable operation, with severe financial consequences for underutilization of capital and production capacity.
Both scale economies and technology involve high capital costs. Early estimates of capital requirements in the US ranged from US$576 million (in the 1950s) to US$1 billion (1960s) to produce 800,000 cars per year (White 1971, cited in Bloomfield 1978), with marketing costs increasing from 31 to 46 per cent of distribution costs by 2000 (Automotive News, 15 October 2001). Companies also faced heavy expenditure for new model development (with shorter model life cycles of two to three years) and to meet more stringent environmental and safety standards. High capital requirements, overcapacity and low margins have historically necessitated industry rationalization with long-term trends towards mergers, strategic alliances and partnerships needed to provide technical economies of scale, capital resources for model development, more automated production, and increased marketing efforts (Bloomfield 1978; Bando 2000). Industry ration- alization was also necessitated by low margins and declining profitability, partly the result of intense competition and overcapacity.
Overcapacity resulted in a big drop in profitability. Of the major car producers in 1973–87, only General Motors’ net income as a percentage of net revenue averaged around 5 per cent, with Ford and Chrysler on occasion exceeding this. In general, the figure was below 5 per cent, with the last three companies registering significant, consecutive losses (Bloomfield 1991).
Profits for many companies in Western Europe were small even before the oil crisis, and only Daimler and Peugeot made substantial profits and retained full profitability. Several large corporations had to be bailed out (British Leyland) while others went bankrupt (Iso, Jensen, MG Rover), changed own- ership (Ferrari, Lamborghini, Aston Martin, Maserati) or merged (Citroën/
Peugeot, DAF/Volvo). Overcapacity was expected to remain a problem until the end of the 1980s, possibly with as much as 25 per cent of the world’s car capacity needing to be phased out for industry viability (Bloomfield 1978).
Late-comer and specific challenges
As an infant industry, Proton’s competitiveness was further constrained by technology transfer problems and a limited domestic market size. Economies of scale requires exports, which in turn depend on technology (for product design and efficient production), marketing and distribution. The reason why production scale is not large is that the product is not competitive enough to capture a larger market share. But if it does not capture a larger market share it will not become more competitive. Here the technology acquisition strategy of the government is critical, since scale of production cannot be vast at the outset, and requires significant state assistance in the form of conditional subsidies, whether explicit or implicit, if the enterprise is to succeed. Thus, the problem of scale economies needs to be located within the context of technology acquisition.
In addition, Proton also had to meet government objectives to rationalize the local automotive industry; spearhead the development of component manufacturing industries; provide incentives for the acquisition and upgrad- ing of technology, engineering norms and industrial skills; and promote New Economic Policy (NEP) restructuring objectives (by developing Malay participation as well as creating and sustaining employment). These were in part shaped by the political and economic imperatives discussed in Chapter 3.
Specifically, a national car project allowed the government to meet the growing demands of the Malay middle class by promoting backward linkages with local component manufacture, while at the same time addressing the economic challenges of industrial upgrading. This meant that Proton had to upgrade its own technological capabilities as well as those of its local vendors to ensure that government objectives were met, and local component costs were kept low.
In return, Proton was provided with learning rents in the form of tariff and excise duty exemptions, and tax rebates for product development. Successful technology acquisition depends on the terms of technology transfer agreed with the technical partner, and the firm’s ‘absorptive capacity’ (i.e. existing knowledge and competence, and the intensity of effort or commitment) (see Bell et al. 1984; Jacobsson 1993; Kim 2004). However, Proton’s technology acquisition was affected by political considerations, namely NEP objectives to promote Malay (and bypass domestic Chinese) capital which comprom- ised learning and efficiency. The haste of negotiations with Mitsubishi along with managerial constraints (inherited from the NEP) compromised technol- ogy acquisition. Proton’s competitiveness was further hampered by the need to support (inefficient) local component manufacturers through technology transfers. Finally, Proton had no control over marketing and distribution.
Domestic distribution, image and branding were handled by Edaran Oto- mobil Nasional (EON), the national distributor which was not owned by Proton. This led to coordination problems between production and distribu- tion, conflicts of interest (e.g. Proton was unable to even determine accessory
fittings and retail prices), and price increases which profited EON at the expense of Proton (The Edge, 12 April 1999).1 These constraints created additional challenges for Proton as a late comer, and subsequently also affected its performance after privatization.
Background
The origins of Proton can be traced back to the government’s efforts to promote local content and greater efficiency in the 1960s through integration of a fragmented auto industry. This aimed to reduce imports, save foreign exchange, create employment, develop strong forward and backward linkages with the rest of the economy, transfer industrial technology, and increase Malay automotive participation. However, despite government measures to promote local content, efficiency and greater Malay participation, the market remained fragmented by the late 1970s, with a multiplicity of assembly plants producing low volumes of numerous makes and models due to the small market.2 The refusal of assemblers to standardize design, material and dimensional specifications further limited economies of scale (Doner 1991).
Local content was around 8–10 per cent and local component manufacture largely involved assembly of non-proprietary items (e.g. tyres, batteries, exhaust systems, paints) or imported parts, with low levels of technology (Chee and Fong 1983; Doner 1991; Tharu 1994). Malay presence in the industry was minimal, and mainly restricted to auto distribution and recondi- tioning, usually in the weakest firms (Doner 1991). The industry remained local Chinese-dominated, import-dependent and disappointing in terms of its contribution to industrialization. Total sales rose in 1983, but imports for the assembly sector grew faster, while the industry’s (parts and assembly) contribution to total manufacturing output and GDP declined (Doner 1991).
By June 1978, problems in the auto sector, combined with stagnation and poor economic performance, led to a change in government policy, from fostering import-substitution type industries run by foreign car manufac- turers, to state-led development of a Malaysian car as key to a Malay-led, second-stage import substitution (Doner 1991). This aimed to address issues related to constraints on economies of scale posed by too many assembly plants and a small domestic market; the domination of the local auto industry by joint ventures between Japanese car manufacturers and local Chinese assemblers, to the exclusion of Malay companies; and the slow progress of local production of auto parts (Bando 2000).
The Heavy Industries Corporation of Malaysia (HICOM) was created in 1980 to undertake large-scale ventures in strategic manufactures,3 including a national car. Following unsuccessful talks with Japanese car manufacturer Daihatsu,4 Mahathir proposed the national car project to Mitsubishi Corporation (MC) in October 1981 after his appointment as Prime Minister that year (Doner 1991). The project was approved in November 1982 and a contract was signed between HICOM and MC and its subsidiary, Mitsubishi