Brief background

Indonesia and Malaysia are two neighboring countries that have sometimes been collectively grouped together into what is known as the Malay Archipelago. The basis for the term “Malay Archipelago” could have been language and/or ethnicity (Pribumi/Bumiputra).

The total territory of Indonesia was a Dutch colony (when it was referred to as the Netherlands Indies) since 1815. On March 8, 1942, the Commander of the Royal Nether­lands Indies Army, General ter Poorten, signed the act of surrender to the Japanese Commander in Subang, a small town in the province of West Java. Subsequently, Indonesia was occupied by Japan until August 15, 1945, when Japan surrendered unconditionally to the Allied Forces. Indonesia’s two foremost nationalist leaders, Sukarno and Mohammad Hatta, seized the opportu­nity to proclaim Indonesia’s independence on August 17, 1945 after Japan’s surrender, whilst the British resumed their rule of Malaya (Peninsular Malaysia prior to the formation of Malaysia in 1965) until August 31, 1957, when Britain granted it its independence. The Malayan peninsula and Northeast Borneo were occupied by Britain for 117 years.

There were some similarities in the economic challenges encountered by Indonesia and Malaysia in the countries’ early post-independence years. Infrastructure development and achiev­ing a more balanced structure of the economy (away from an overdependence on the export- oriented agricultural and mining sectors) were priority areas for both countries. Both countries shared similar concerns over the dominance of foreign-owned firms as well as Chinese-owned firms in these economies.

Another major area of focus was the development of the manufacturing sector — especially the need to enhance the sector’s production to meet domestic needs. Whilst both countries began with import substitution industrialization, the duration of these policies differed — Indonesia from the early 1950s until the early 1980s (after the first oil boom ended) and Malaysia from the 1950s to the 1960s.

For Indonesia, macroeconomic stabilization was of greater importance following economic instability during the period from the mid-1950s to the mid-1960s, involving the twin deficits (balance of payments and budget) and hyperinflation, which had reached a staggering 600 percent in 1965 (Thee, 2012). Greater economic stability and more sustained growth was only achieved in Indonesia in the first decade of Suharto’s New Order Era (1966—98). The two oil booms in the 1970s enabled the Indonesian government to undertake significant investments in physical infrastructure and in health and education facilities, particularly in primary education, as well as support for the agricultural and manufacturing sectors.

However, the first oil boom, which ended in 1982, had the unfortunate effect of the resource curse, which adversely affected exporting activities as Indonesia’s real exchange rate appreciated. However, after the price of oil dropped steeply in early 1986, the Indonesian government finally embarked on a more determined path of export-oriented industrialization. This scheme turned out to be very successful, as from 1987 manufactured exports rose very rapidly, thus following in the footsteps of the East Asian newly industrialized economies.

Malaysia’s oil boom came much later in the mid-1990s with important discoveries in the East Coast of Peninsular Malaysia and in East Malaysia. As in the case of Indonesia, Malaysia also used its windfall earnings from oil to undertake a second round of import-substitution by focusing on heavy industries (automotive, steel and cement). Despite this new emphasis, export manufacturing activities continue to be important in Indonesia and Malaysia. The Asian financial crisis in 1997/98 had a significant adverse impact, especially on Indonesia. The sharp economic contraction in 1998 was followed by the downfall of Suharto on May 21, 1998. In Malaysia, the Mahathir administration survived the crisis by shielding domestic capital via exchange controls and bailouts in the banking sector.