Issues

The Digital Free Trade Zone – A Path to Inclusive Growth?

By Timothy Choy (Analyst, Economics Programme)   |   Posted on

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Executive Summary

  • The Digital Free Trade Zone (DFTZ) is argued to enhance SME activity through the lowering of cost in business expansion and by creating an innovative ecosystem through competition.
  • Immediate beneficiaries of the DFTZ are SMEs that are export-oriented with a strong bias towards goods-centric manufacturing.
  • As the DFTZ reduces Non-Tariff Barriers (NTBs) and positions Malaysia as the trade hub for inter- and intra-ASEAN trade, trade volume is expected to increase substantially.
  • With the completion of the DFTZ, there will be a new demand for “e-Mediary” employments that will target high-skill domestic labour.
  • Details on the DFTZ are still scarce and thorough impact assessments are lacking. This warrants concern as the effects of this huge project may adversely affect the country’s socio-economic conditions.

Introduction

The first-ever Digital Free Trade Zone (DFTZ), an e-hub jointly established by China’s Alibaba Group and the Malaysia Digital Economy Corporation (MDEC), was recently launched at the Global Transformation Forum by Prime Minister Najib Razak.

Playing its part in the National e-Commerce Strategic Roadmap (NeSR) that aims to double e-commerce growth by 2020, the DFTZ will be rolled out in three phases, the first being the eFulfillment Hub that will function as a centralised customs clearance, warehousing and fulfillment facility for Malaysia and the region. The second phase is the Satellite Services Hub in the Kuala Lumpur Internet City (KLIC), which will act as a premier digital hub to facilitate end-to-end support, networking and knowledge sharing for local and global Internet-related companies targeting Southeast Asia. The third phase is the development of a virtual unified government services platform that further provides convenient services for users.

The DFTZ has so far been welcomed as a game changer for equitable growth by equipping small and medium-sized enterprises (SMEs) to take part in globalisation and providing employment opportunities to young entrepreneurs. At a policy level, the DFTZ can be viewed as a timely catalyst for synergy between two independently occurring national initiatives; the SME Masterplan 2012-2020 and the NeSR.

The first of its kind, the DFTZ is specifically designed to prioritise SMEs. At the moment, 97% of domestic businesses are SMEs. Collectively, however, SMEs only contribute 37% to the national GDP and approximately 30% to total employment. The launching of DFTZ hopes to see an increase in this ratio.

Scenario Analysis on SMEs

A direct effect of the DFTZ will be an overall reduction in internal production and transaction costs. SMEs that operate a traditional brick-and-mortar business model face a high fixed cost because they require a physical establishment. Scaling up business would mean acquiring another physical establishment and therefore duplicating inventory costs – a business expansion plan that is unfeasible for many SMEs that, by definition, possess limited capital.

Under the DFTZ, the eFulfillment Hub will enable SMEs to outsource warehousing and shipping; essentially eliminating the need to maintain multiple physical storefronts in the event of business expansion. Coupled with centralised customs clearance, this increase in demand for warehousing in the eFulfillment Hub will produce economies of scale and act to reduce administrative costs associated with delivery (Kuwayama, 2001). The use of e-commerce, on the other hand, will provide greater market access to SMEs.

The ability of SMEs to tap into new markets is usually undermined by the cost of acquiring information – distribution channels, buyer preferences, quality standards, policy changes, as well as legal and bureaucratic procedures. By contrast, e-commerce acts as a one-stop solution by connecting sellers and buyers directly. SMEs are able to acquire production inputs more efficiently by sourcing them directly from sellers who meet their business preference. In this respect, the DFTZ will improve growth prospects for SMEs.

With its emphasis on a fulfillment hub, it can be argued that the DFTZ is a goods-centric free trade zone. However, not all SMEs will be affected by the DFTZ in the same way. In the short-term, SMEs that are manufacturers of export-oriented products will be the primary benefactors of the zone. These SMEs produce intermediate goods that are primarily for the global market and are thus ‘vertically integrated’ into the global supply chain. By virtue of their business operations, such SMEs will stand to benefit more from the reductions in cost accrued by the free trade zone. Conversely, SMEs that primarily produce import substitutes tend to be aimed at the domestic market.

Leveraging on the DFTZ also requires an SME to possess the ability to design a successful adaptive business strategy; a measure of “e-Readiness” of some sort.[1] The effect of trade liberalisation and deregulation in Argentina on SMEs is a case in point. Yoguel (1998) noted that a third of SMEs in Argentina had a limited probability of survival due to productive and managerial constraints, technology backwardness and the inability to adapt and incorporate new products with new export platforms. e-Readiness also stems from an SME’s ability to compete with other firms.

Intuitively, a free trade zone works both ways; integrating domestic SMEs into the international market and vice versa. E-commerce tends to shift negotiation powers away from the sellers to the buyers by reducing the cost of switching. Buyers need not spend time searching for alternative products at physical stores or through catalogues and newspapers. Additionally, buyers are empowered to search for sellers with the lowest price for a specific product or service.

This puts immense pressure on domestic SMEs to innovate and compete on all fronts. As is always the case with increased competition and upgrading, those who are not able to adapt are likely to fall behind. The 2009 closure of Borders Bookstore comes to mind with the Guardian’s headline flashing “Hailed as a ‘sure fire’ success, the bookstore chain was killed by Amazon and cut-price supermarkets”.[1] The idea of E-Readiness can be traced back to McConnell International (2000), which rates the degree of E-Readiness of countries in Latin America and East Asia by measuring five attributes.

[3] Data obtained from Department of Statistics Malaysia, Official Portal.

[4] Data obtained from Profile of Small and Medium Enterprise (2011), Department of Statstics Malaysia.

Managing Editor: Ooi Kee Beng Editorial Team: Regina Hoo, Lim Su Lin, Nur Fitriah, Ong Wooi Leng