Yay, FDI FTW! Wait a minute…

I rarely care enough to think about domestic issues in Malaysia, but a severe bout of college “senioritis”[1] has led me to this intellectual exercise. My attention is turned to Lynas, an Australian mining company that plans to set up a rare earth refinery plant in Gebeng, Pahang. At this juncture, the core of the dispute appears to be the refinery’s impact on public health and the environment. With the government’s decision to grant Lynas a Temporary Operating License, this issue has never been more politically-charged. I am going to “conveniently” ignore the health/safety dimension here, not because it is unimportant, but because there is little to add to a technical discussion that remains unresolved even among the experts. It is probably more fun to poke into the economics of the issue.

So how does Lynas justify the refinery plant economically? From the onset, it attempts to impress with big numbers. According to Lynas, the RM700mn operations will turn Gebeng into a major rare earth hub – one that is projected to meet a third of the global demand for rare earth materials within 2 years. By attracting advanced chemical companies to set up shop near the refinery, Lynas also claims a regional multiplier effect of at least tenfold. This would ideally spark the virtuous cycle of job creation, asset reflation, and capital reinvestments. Perhaps the biggest revelation is this – the refinery’s annual export is estimated at over RM5bn, a cool 1% of the nation’s GDP! Surely, that would be a huge boost to our aspiration to become a high-income nation by 2020. Has Christmas come early for Malaysia?

Well, I have my reservations. One crucial caveat to note is that Lynas secured a fat 12-year tax break from the government for the refinery. This represents billions of lost corporate tax revenues over the next decade – tax revenues that could have helped build infrastructure for complementary industries or lower income/sales taxes that affect Malaysians more directly. More importantly, this tax exemption substantially curtails our opportunity to raise income per capita via Lynas. The firm now gets to retain all of its earnings, which when repatriated back to its home country, actually contributes to the Gross National Income (GNI) of Australia, not Malaysia. One may easily conflate between the two, but GNI is the indicator (not GDP) that gauges our progress towards hitting the USD15000 per capita target by 2020. While it contributes to domestic output, foreign direct investment does not necessarily create localized wealth effects, especially if the government forgoes a chunk of the firm’s capital returns.

What about employment then? Doesn’t the refinery plant create jobs for its surrounding community? Yes, but only on a small scale. The refinery plant, also dubbed as the Lynas Advanced Materials Plant (LAMP), requires only 350 skilled workers. Compared to the thousands of livelihood that might be at stake, this figure is miniscule. Not to mention, rare earth refining lies relatively low in the sector’s global supply chain, preceding more value-adding activities such as R&D and manufacturing. The upside is no different from that of helping Intel or Dell to assemble chips and laptop computers. The downside however, is potentially daunting. Since our engagement with Lynas is in the commodities sector, the financial health of the refinery is susceptible to the fluctuations in the price of rare earth minerals. The fact that rare earth minerals are traded in private markets, instead of exchange-traded markets makes price monitoring and hedging activities even more difficult.

And now to the extraordinary claim that the Gebeng refinery would generate a tenfold multiplier effect. This projection substantially exceeds the baseline projections of typical industrial projects, which usually range from 1.2 to 1.4. Unless Lynas can single-handedly create a thriving, mega cluster of suppliers, competitors and consumers, in other words – a Silicon Valley of rare earth players in Malaysia, I am skeptical of the refinery’s multiplier effect. Indeed, commodities-based operations usually yield lower multiplier effects due to the little need for locally-manufactured components. Besides, the industry for rare earth processing and manufacturing barely exists in Malaysia. It is hard to imagine then, how new industry players could converge in the Gebeng locality, considering the potential lack of core competencies and other barriers to entry into the industry. If anything, Lynas would probably be vertically integrated throughout its refinery operations and operate alone in the area.

Economic analysis – a game of assumptions…

Based on my personal analysis, the economic benefits of setting up the refinery plant appear to be exaggerated. Then again, economics is a game of assumptions. One could always justify the construction of the refinery by tinkering with a favorable set of counterfactuals. The point is – conceptually at least, building that plant may not be a good idea.

[1] A dramatic loss of academic motivation that plagues graduating university students, caused by the possible illusion that one’s CGPA is (pretty much) set in stone and/or a premature anticipation to post-graduation plans, for better or for worse.

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4 thoughts on “Yay, FDI FTW! Wait a minute…

  1. 1. There are good reasons why economists use both GDP and GNI. The comparison between GDP n GNI above is absolutely right. But, if my memory doesn’t fail me,
    GNI = GDP + payments from abroad – payments to abroad.

    the GNI measure would give us a lower figure. But not 100% of the amount exported is repatriated back to Lynas. Apparently, their ebitda margin is estimated to be 68%, So I’m guessing we would still own have that 32%. Say, they export 500 million. they earn 68% of that and repatriate 340 million back. Minus that away and our GNI would still rise by 160 million

    (I got the figure 32% from macquarie research: http://www.google.co.uk/url?sa=t&rct=j&q=lynas%20corp%20ebitda%20margin&source=web&cd=6&ved=0CEkQFjAF&url=http%3A%2F%2Fwww.macquarie.com.au%2Fdafiles%2FInternet%2Fmgl%2Fau%2Fapps%2Fretail-newsletter%2Fdocs%2F2012-01%2FLYC240112e.pdf&ei=lPBXT82fHsSg8QOc2Mj-Dg&usg=AFQjCNFHwp2BiIqJJtkATzdd7CHv-KwowQ)

    But all above are just accounting identity. One might ask how we might get that 160 million. So,for example, Lynas export 500million USD worth of refined rare earth this year. Lynas won’t earn all of that 500 million. They will need to pay Tenaga for electricity, pay water utilities to use the water, pay whatever. Those are some of the possible ways we could get a share of that 500 million ( just a side point to concern with here- Are we really selling them subsidised electricity?)

    So, yes. I agree that some of it is repatriated back. But, not all.

    2. There’s no other way in increasing real wage. Sustainable rise in real wage can only come from improvement in productivity. And, Lynas is giving that boost to our productivity. Yes, they might employ only 350 person. But, we need to face the fact. That’s how we can have high income workers. Would we rather have a factory that produces toys and employ 1000 people?

    • Very good comments by Jia Cheng especially on the retained exports earnings. GNI is lower due to repatriation of MNC..maybe if we could reduce our energy subsidies, we could actually improve our GNI

    • Jia Cheng, you are right about retaining part of Lynas’ earnings via other channels besides taxation. I was a bit deterministic to say that all of its earnings would be repatriated back to Australia. You mentioned some of the possible ways, i.e. purchasing raw materials like water or chemicals from local suppliers/producers. While they do contribute to the bottom line of Malaysian firms, I think the value added is still limited, considering that Lynas does not hide their intention to take advantage of cheaper or even government-subsidized energy. I’d imagine that Lynas intends to import the other important production inputs – thus limiting the multiplier effect in the locale. I’m also not too sure about the profitability of Lynas actually. Referring to the same piece of Macquarie research, didn’t the company actually make losses these past two years? I assume the positive profit projections were made with implicit assumptions on the success of the LAMP project here, as well as projections on rare earth mineral prices. If that is the case, we cannot discount the inherent financial risk that the project carries as well.

      There is no doubt that we need quality FDI to facilitate technological spillovers, raise skilled human capital etc. But I guess the point I was trying to make was, we also have to carefully evaluate the sustainability of each FDI proposal. Lynas operates in a niched commodities sector, which subjects it to world price fluctuations. Assuming Lynas plans to invest here in the medium to long term, I’d argue that we would be increasing our reliance on commodities revenues, which makes us even more vulnerable to external demand shocks. (Our GDP growth apparently wavers by a percentage point depending on oil prices) Considering that there is a recognition for emerging economies to transition into manufacturing/services, would Lynas help us to in that direction? I’d concede that in the short term, for sure – Lynas would help shore up our FDI numbers, but it may not be a strategic investment in the long term.

      As for real wages, they would only increase in a competitive industry. As far as I’m concerned, LAMP would be the only rare earth refinery plant in Malaysia. The monopolistic power it acquires in this new industry in Malaysia could put a downward force on wage increase. If wage increase does come via government intervention, Lynas could be compelled to leave as it came here for cheap labor in the first place.

      As for real wages,

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