ASEAN Beat | Security | Southeast Asia

The China-Malaysia Digital Free Trade Zone: National Security Considerations

While the DFTZ promises growth for both Malaysians and Chinese enterprises, Malaysia must take care to ensure its digital independence.

By Hugh Harsono for
The China-Malaysia Digital Free Trade Zone: National Security Considerations

A Malaysia’s national flag flutters next to the Chinese national emblem during a welcome ceremony for visiting Prime Minister Najib Razak outside the Great Hall of the People in Beijing, Nov. 1, 2016.

Credit: AP Photo/Andy Wong)

China has been pursuing an aggressive campaign of foreign direct investment (FDI) in various developing nations around the world, most notably owing to its expansive Belt and Road Initiative (BRI). Chinese FDI revolves primarily around developing infrastructure in foreign countries, a concerning fact given Beijing’s control of various lateral and horizontal enterprises involved in the BRI, to include lending institutions, construction workers, and matériel suppliers.

However, a new form of power projection from China has emerged in the last several years, primarily conducted through technology and e-commerce. These two factors have played a significant role in driving innovation and success for economies throughout the world, with Asia being a prime location for this increased influence given the region’s manufacturing strengths. Digital free trade zones, a relatively new concept in the startup ecosystem, are physical regions promising benefits to digital trade partners, with Malaysia being the first example of a true digital free trade zone.

Like many other Asian economies, Malaysia has experienced unprecedented growth due to participation in the startup and e-commerce space, with some predictions pointing to Malaysia’s e-commerce industry being worth over $8 billion by 2025. Malaysia’s smartphone penetration rate is further driving these statistics, with nearly three in five of all e-commerce consumers placing their orders via smartphone. These factors, among others, spurred the launch of the Digital Free Trade Zone Initiative (DFTZ) between China and Malaysia in March 2017. The example of Malaysia’s DFTZ offers an interesting viewpoint into an intersection merging national defense, technology, politics, and economics, particularly as China’s influence around the globe continues to grow within these respective sectors. This is especially prevalent given the growing importance of technology and e-commerce in the global competitive marketplace, with China accounting for over half of global online transactions currently.

The Concepts Behind Malaysia’s DFTZ

The Digital Free Trade Zone in Malaysia is envisioned to help small and medium enterprises (SMEs) grow and develop by streamlining primarily e-commerce specific functions. Removing critical barriers to growth such as high tax rates, customs clearances, and inspections on foreign goods are all concepts that will help jumpstart SME growth rates, with the DFTZ focusing on bootstrapping Malaysian startups. Furthermore, Malaysia’s DFTZ benefits from powerful backers such as the Malaysia Digital Economic Corporation (MDEC), China’s Alibaba Group, and the Electronic World Trade Platform (EWTP), which all serve to validate the DFTZ’s concept to help boost international e-commerce trade between China and Malaysia.

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Malaysia’s DFTZ’s goals are predominately focused in three main areas: an e-fulfillment hub, an e-service platform, and a satellite services hub. Strategically located near Malaysia’s high-traffic Kuala Lumpur International Airport (KLIA), the e-fulfillment hub is being developed to create expedited e-commerce delivery and logistics capabilities for Malaysian-Chinese trade. The e-service platform’s capabilities allow for direct communication between Malaysian businesses and Chinese manufacturers. Lastly, the satellite services hub is intended to help incubate startups on both sides of the Malaysian/Chinese digital border, ensuring further investment into the digital economy through promoting tools such as digital payments, insurance services, and human capital development.

Malaysia’s DFTZ also has the intended effect of reflecting Malaysia’s readiness for e-commerce, and by extension, economic growth. By establishing key pieces of critical infrastructure and logistics, both Malaysian private and public organizations are able to demonstrate the capacity for competition on a larger scale. The DFTZ’s contribution to job creation must also not be ignored, with the DFTZ’s initiatives to train thousands of people ranging from tech-savvy entrepreneurs to logistics warehouse workers being a powerful indication of Malaysia’s booming e-commerce sector.

Supporting the Local Malaysian Economy

April 2018 marked the first true use of the DFTZ, with over 100 SMEs in Malaysia utilizing Alibaba’s Lazada platform to market their products within Malaysia and neighboring Singapore. Thousands of other SMEs also registered participation in the DFTZ in 2018 and 2019, all with the goal of helping SMEs go digital by 2022. This ambition of streamlining digitization efforts has resulted in Alipay-integrated domestic banks like Maybank and CMIB experiencing significant amounts of growth, with the e-commerce market being valued at $4 billion in 2018. Other large-scale Malaysian-based companies beginning to reap the rewards of the DFTZ include logistics and infrastructure companies such as courier network POS Malaysia and KLIA-owner Malaysia Airport Holding Berhad.

The DFTZ has also enabled increasing amounts of foreign direct investment (FDI) into Malaysia. Within several months of the DFTZ opening, Chinese private companies registered over $295 million worth of FDI into Malaysia, rapidly expanding Malaysia’s e-commerce industry. Additionally, two separate government initiatives announced in 2019 tied directly to the DFTZ ensured the growth of FDI into Malaysia. The DFTZ has further enabled record growth numbers to Malaysia’s trade surplus, with the nation registering an 11 percent increase when compared to 2018.

Examining the DFTZ Through a Security Lens

No doubt the DFTZ has shown great promise in the last three years, with the booming e-commerce industry highlighting this specific point. However, in light of an improved e-commerce ecosystem within Malaysia, private and public enterprises are at risk of becoming leveraged following prolonged investment from China banks and other Chinese-based companies. Two scenarios that create challenges for Malaysia in both the defense and technology sectors are China’s proven “port-park-city” model owing to an over-leveraged Malaysian government, as well as a conflicted Malaysian e-commerce framework built upon overdependence on China-originated platforms.

A key component of Beijing’s power projection throughout the world is mixed defense-industrial infrastructure projects. China’s “Shekou Model,” more commonly known as the “port-park-city” model, typically involves intensive infrastructure development and FDI investment from Chinese origins, with work being done nearly exclusively by Chinese workers who are in turn financed by China-affiliated banks. The “port-park-city” model has the eventual goal of creating enough infrastructure to develop a port to fuel the establishment of Special Economic Zones (SEZs), thereby establishing a business park that could turn into a city, as described by a Royal United Services Institute for Defense and Security Studies paper. In the case of Malaysia’s DFTZ, this has severe implications given the DFTZ’s prime location in the Malacca Strait, a hub for military defense and commercial interests in Southeast Asia.

The use of “debt-trap diplomacy” by China provides further concern over the DFTZ, raising the specter of nations losing vital infrastructure to Chinese ownership. This notion has extreme implications on the national security front and within the economic sphere, with innovators seeking development in Malaysia potentially experiencing a long-term loss of investment, infrastructure, and even intellectual property theft. Therefore, the Malaysian government must exercise extreme caution in moving forward with the DFTZ, particularly from a national defense perspective.

Additionally, Alibaba’s heavy involvement in Malaysia’s DFTZ is another point of concern from a security perspective. Alibaba has certainly played a significant part in ensuring the DFTZ’s growth on both sides of the digital Malaysia/China border. However, reliance solely on Alibaba technology — to include the Lazada e-commerce platform and digital payments tool Alipay — may set Malaysians up for failure in the future. The lack of diversity in manufacturing, hardware, and software tools creates an overdependence of Malaysian enterprises on Alibaba, providing an unfair advantage to enterprises choosing to participate in the Alibaba environment versus those that decide to utilize other technologies. This has specific national security implications if Alibaba, or other Chinese firms, continue to provide significant amounts of digital infrastructure development for both Malaysian civilian and governmental enterprises.

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Legislation in China, most notably the 2017 National Intelligence Law and 2017 Cybersecurity Law, forces cooperation between private organizations and state intelligence apparatuses, to include political groups. These laws bear similarities to programs like that of the U.S. National Security Agency’s PRISM surveillance program, among many others. However, Chinese laws go beyond NSA’s data aggregation and collection programs in ensuring the intelligence service’s access to Chinese technology firms. As long as the competitive advantage in Malaysia’s DFTZ favors Chinese firms over Malaysian ones, exposure to infiltration by China’s intelligence services through Chinese digital investments would only continue to rise within Malaysia, especially through avenues such as the DFTZ. Therefore, Malaysian organizations must strive to develop their own digital infrastructure frameworks, ensuring Malaysian e-independence and transparency as opposed to an overreliance on foreign forces.

While Malaysia is projected to continue to experience high amounts of interest in its e-commerce sector, Malaysian organizations must tread carefully in pursuit of this future growth. Malaysia and China have very close trade ties, and it would benefit both parties to continue this partnership for economic growth. In spite of this beneficial relationship thus far, Malaysians must keep in mind that overdependence on foreign infrastructure can have disastrous effects on a nation’s defense objectives, economy, and even Malaysia’s self-determination.

Conclusion

So far, the DFTZ has proven itself to be a model for international growth, with its streamlining of trade processes enabling the rise of e-commerce in both the Malaysian and Chinese economies. The DFTZ’s marked ability to emphasize online trade was one of the first, if not the first, agreements reached by two countries to facilitate bilateral growth specifically in the digital sector. The concept of the DFTZ has even spread as far as the Middle East, with the government of Dubai currently planning an $870 million free trade zone for e-commerce named Dubai CommerCity (DCC).

However, when examining the DFTZ through a national security lens, one begins to understand how China is developing methods for access and placement within the digital apparatuses of other nations. Therefore, while the DFTZ does promise growth for both Malaysians and Chinese enterprises, Malaysians must begin to develop their own e-frameworks, ensuring Malaysian digital independence and avoiding overreliance on foreign forces.

Hugh Harsono is currently serving as an officer in the United States Army. He writes regularly for multiple publications about cyberspace, economics, foreign affairs, and technology. He can be found on LinkedIn @HughHarsono. This content does not contain information of an official nature nor does the content represent the official position of any government, any organization or any group.