News in Charts: Malaysia’s pivotal role in the AI arms race

Malaysia has experienced rapid growth in the last five years, as have numerous member states of the Association of Southeast Asian Nations (ASEAN). Malaysia’s GDP has expanded more than 17% since 2019; only Vietnam, the Philippines and Singapore have grown faster within the free trade bloc. One of the key drivers of Malaysia’s growth has been the strong trade ties it has built with China, starting after the PRC’s accession into the World Trade Organisation (WTO) in 2001 and accelerating in the 2020s.

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Malaysia’s trading relationship with the US is also important to its economy; last year, Malaysian exports to the US overtook its exports to the rest of Asia (excluding China and Hong Kong). As US tariffs on Chinese goods currently stand at 145%, Malaysia has two dilemmas to navigate. First, there is the threat of increased tariffs levied against Malaysia if its practice of re-exporting Chinese goods to the US accelerates. Second, demand for southeast Asian goods is at risk of diminishing if China looks to flood ASEAN markets with cheap substitutes. This scenario, when coupled with the blow to global demand from President Trump’s ‘Liberation Day’ tariffs, could lead to deflation.

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However, Malaysia is more than just a re-exporting hub for China — it also enjoys relatively high levels of foreign direct investment. According to World Bank data, it has attracted FDI of between 2-4% of GDP on average per year, consistently above the global mean. With Singapore — South-East Asia’s financial hub — on its doorstep, and ever-growing manufacturing prowess, Malaysia has been a popular candidate for Western multi-nationals trying to decouple their supply chains by implementing ‘China plus one’ strategies.

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In particular, Malaysia has openly embraced the high-tech industries of semiconductor manufacturing and datacentres — both of which are considered the main factors of production for Artificial Intelligence (AI) development. It has historically positioned itself at the latter stages of semiconductor manufacturing supply chains, in the production processes of assembling, testing chips and packaging (ATP). Huge levels of this manufacturing capacity have already been installed in the northern state of Penang — so much so, in fact, that the country received a tariff exemption for semiconductor exports to the US. However, Malaysia will certainly also now be considering the installation of chip factories, placing it at the front of the supply chain. This includes higher-value activities such as integrated circuit design and wafer fabrication – the likes of which are dominated by a few select companies, including Taiwan Semiconductor Manufacturing Company (TSMC).

In the south of Malaysia, cheap land and low electricity prices (thanks to Malaysia’s coal-heavy electricity-generation mix), as well as the prospect of a new special economic zone between Malaysia and Singapore, have made Johor a prime destination for datacentres. All the largest American cloud providers, including Amazon, Alphabet, Microsoft and Oracle, have located some of these energy-intensive warehouses there. The scale of Chinese presence is no different. Bytedance, the parent company of social media app TikTok, has set up an AI hub in Johor, and other Chinese tech giants like Huawei and GDS services have also installed datacentre capacity.

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In recent months, this activity has led to concerns that China may be exploiting cloud capacity in Malaysia to gain access to American-made semiconductors (which are heavily utilised in the construction of datacentres) that are otherwise banned from entering China. Although the trend of semiconductor imports from the US has slightly receded, chip imports from Taiwan and Singapore appear to be on the rise. Malaysia has proved to be perhaps the most pivotal entity in southeast Asia for both China and the US in the transatlantic AI race.

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Meanwhile, Southeast Asian equities have barely recovered from the ‘reciprocal’ tariffs initially implemented by the US on ‘Liberation Day’ (the average tariff rate for ASEAN member states was 33% before a 90 day suspension was put in place). Unlike the EU and China, individual ASEAN member states do not possess leverage large enough to retaliate effectively against America, even if they were to act as a unified bloc. Vietnam and Cambodia were some of the first countries to offer 0% tariffs on US goods in a bid to lessen the hefty tariffs levied against them, and Malaysia even proposed a critical minerals deal to slash its initial US tariffs. Decoupling from China would be just as difficult as forgoing exports to the US if either side was to insist on geopolitical alignment. But ultimately, Malaysia may not have to pick a side, as it continues to benefit from supporting both parties in the US-China AI race. Successfully developing a front-end semiconductor fabrication plant is likely to be Malaysia’s next goal, to solidify its already strong position in the semiconductor supply chain.

The views expressed in this article are the views of the author, not necessarily those of LSEG.

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