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Authors: Hteik Tin Min Paing, Yan Lynn Region Head: Hteik Tin Min Paing
Editor: Sakshi Sanganeria
Illustration by Michelle Faith Lee
Abstract
Tariffs, depreciation of Chinese yuan against the US dollar and the loss of confidence by foreign investors has led manufacturers in China to relocate their production elsewhere. This article examines the need for new regional manufacturing hubs and what steps are needed for countries to fit this bill- including sound policy, infrastructure and industrial hubs.
Even though the impact of trade war is likely to dwindle in future as both sides have negotiated the phase one trade deal and expressed willingness to impede retaliation, recent issues like the coronavirus pandemic have increased production and labour costs in China, disrupted the supply chain, and as a result, refuelled the manufacturing exit. Big global companies like Nike, Panasonic and Sony have already shifted out or at least shown interest in Southeast Asia for their exit, and as such, are in prime position to capitalise on this opportunity.
Countries Vying for the Opportunity
The question remains how well positioned Southeast Asian countries are to take this opportunity. Companies normally look for countries with expertise of labour force (similar to that of China), political stability for ease of doing businesses, low wages and transportation cost and good infrastructure to support the production.
Even though some countries fit the bill for most of these necessities, they have their own challenges too.
Some of the poorer countries such as Laos and Myanmar do not have sufficient infrastructure nor political stability to facilitate the shift. On the other hand, countries like Vietnam, Malaysia, Thailand and Indonesia have emerged as winners of the trade conflict and will continue to vie for a bigger share of the pie post-COVID-19. All of these four countries have a relatively stable political climate and cheap labour costs. Therefore, the competition will largely be in terms of implementing better policies for sound investments, building infrastructure to support production and creating industrial clusters for knowledge flow and expertise to attract manufacturers.
The need for sound policy to Capitalise on the Manufacturing Shift
Southeast Asian governments can improve trade and economic policies to attract manufacturing firms. For instance, Vietnam has benefitted from liberalising the trade policy and attained trade benefits from bilateral agreements and free trade agreements such as CPTPP and EVFTA. Access to US and EU markets with lower tariff barriers and duties will attract significant FDI. In the last 5 years, Vietnam’s share in global exports increased with the highest manufacturing FDI growth not only in Southeast Asia but also compared with countries like Japan, Taiwan and India. Vietnam has now matched with gross export levels of Thailand and Malaysia and surpassed Indonesia (Nguyen, 2020).
Currently, all Southeast Asian countries are preparing to sign the Regional Comprehensive Economic Partnership (RCEP) involving Australia, New Zealand, China, Japan and South Korea (Rahman, 2020). Regarding trade deals with Western countries, there are more bilateral agreements than multilateral agreements due to skepticism on investment liberalisation. Hence, Brunei, Malaysia, Singapore and Vietnam are the only signatories of CPTPP and only Singapore and Vietnam have signed bilateral agreements with European Union (“Countries and Regions: Association of Southeast Asian Nations (ASEAN),”2020).
Although developing countries need to be cautious with investment liberalisation, countries like Indonesia and the Philippines should consider striking more trade deals, which they have been contemplating for years. Indonesia has revealed the “Making Indonesia 4.0” Plan in 2018 and shown interest in joining Trans-Pacific Partnership (TPP) (Tani, 2018), whereas the Philippines has considered joining TPP since 2010.
In order to enhance the ease of doing business and enter more trade deals, economic policies such as competition policy, tax policies, investment protection would need to be reformed. Other policies such as intellectual property protection and labor rights also need to be in line with international standards. Regarding policies, one notable example is the Philippines’ reform in Corporate Income Tax (CIT) with the Corporate Income Tax and Incentives Rationalisation Act (CITIRA). Since the previous CIT of 30% had a negative impact on foreign investments as well as local business growth (Medina, 2020), such policies should be considered for reform in other countries as well. In addition, effective and efficient policymaking would be necessary for Southeast Asia to become the next world factory like China.
An impending infrastructure reform and industrial clusters
Highways, airports, sea ports, sufficient and low-cost electricity are important factors in the firms’ decisions to move into certain countries. Singapore, Malaysia, Thailand, Vietnam, Indonesia and the Philippines stand at high ranking of World Bank infrastructure rankings.
Developing countries like Cambodia, Laos and Myanmar would need to improve necessary infrastructure by making long-term investment plans. Furthermore, automation and mechanisation will be important to increase productivity especially for countries like Malaysia, Thailand and Vietnam. Thailand’s ‘Thailand 4.0 economic strategy’ emphasises technology and automation. Vietnam and Malaysia have also initiated plans on automation in order to be more efficient and productive. The Philippines and Indonesia, however, have lagged behind in this arena due to education and skills requirements, indicating the need of medium and long-term plans for these aspects. Since automation is a solution to rising labor costs and low productivity, all the countries should make necessary plans to remain competitive.
Knowledge and technology transfer, alongside the economies of scale and productivity, are just as important factors for consideration as the labour wage for manufacturers looking to enter Southeast Asia. For example, if a worker in China costs twice but produces three times as much as a Vietnamese worker, it will not be a wise decision to enter Vietnam and pay less for a much lower productivity. Therefore, low cost alone is not enough. It must also be a cost-effective decision to enter Southeast Asia. In order to have a level of productivity relative to the cost, industrial clusters (geographic areas where firms share common technologies, have similar production facilities, markets and worker skill needs) are essential to boost knowledge transfer and hence accelerate economies of scale. According to Bagley (2019), with everything constant there is a negative correlation between network efficiency and geographic distance to a cluster’s centroid. As such, countries should strive to cluster similar firms together as much as possible to gain a competitive edge.
This leads to another question of whether the countries should go for a quantity or quality approach for creating clusters. Countries could choose to go for a much broader strategy such as Thailand’s Eastern Economic Corridor (EEC) which includes wide-scale development projects for electronic & automotive sectors and tourism industry. They could also go for more concentrated and focused development projects such as Malaysia’s ‘Silicon Valley’ for semiconductors which have seen about $3 billion in foreign investments during 2019 and Vietnam which positions itself as a go-to exit for electronics manufacturers (Lee, 2019).
For example, it would not be a wise decision to attract the electronics manufacturers for a much economically weaker country like Cambodia by competing with Vietnam. Instead, it would be better to fill the gaps in other missing sectors which see lesser competition.
As the countries in Southeast Asia strive to create a more conducive environment for investors fleeing China, overtime Southeast Asia will become as competitive as China. One index that is used to measure this is the index developed by Finger and Kreinin called export similarity index which in this case could be used to rank countries according to their overall overlap in the share of exported products with China.
According to Pomfret (1981), when the product similarity index rises, the export structures of two countries converge. This would infer that the investment policies and infrastructures which lay the foundation of industrial clusters between Southeast Asia as a whole and China will get more and more similar overtime. This would eventually lead to two regions becoming more competitive in the future which could end up with both regions specialising in a few sectors and letting go of others to avoid competition and leverage on their natural advantage.
Therefore, it is important for Southeast Asian countries to factor in long term economic consequences while positioning themselves as preferred exits for the manufacturing exodus.
References
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