Southeast Asia: The next manufacturing hub? Reality trumps ambition
Southeast Asia: the next manufacturing hub? Reality trumps Ambition
WRITTEN BY STEPHEN NAGY AND HANH NGUYEN
30 November 2020
US-China relations began to deteriorate in 2018 with a tit-for-tat trade war that has morphed into a full-blown strategic competition. The COVID-19 pandemic has further accelerated this free fall. Tensions evoking the spectre of a new Cold War have come hand-in-hand with concerns about the concentration of global production networks in China.
The pandemic has disrupted business activities and China’s growing economic and ‘Wolf Warrior’ diplomacy has prompted discussions about the need to reshape global supply chains away from China. Southeast Asia, a region that already has many countries participating in the China-centric production networks, emerged as a new location for businesses wanting to leave China due to a combination of factors such as trade tariffs, geopolitical tensions, and rising labour costs.
Southeast Asia’s comparative advantages
Southeast Asia retains several advantages in the race for foreign investments. Its proximity to China provides businesses easy access to the traditional manufacturing hubs, especially for supply chains that need to stay in China. With a population of 649.1 million in 2018, in which the youth group represents 40 per cent of the total population, the region provides an abundant labour supply for businesses.
Despite the general trend of rising labour cost, minimum wage rates in Southeast Asia remain among the lowest in Asia, a significant advantage compared to China's fast-rising labour cost. For example, Vietnam and Indonesia, two leading candidates for regional manufacturing hubs, have their monthly minimum wage rates under 200 USD. In comparison, minimum wage rates in China’s manufacturing centres like Guangdong, Zhejiang and Jiangsu range from 200-300 USD per month.
US lawmakers and officials are contemplating a ‘reshoring fund’ of $25 billion to encourage critical suppliers to move out of China. Japan earmarked more than $2 billion in subsidies for companies to either bring manufacturing back home or diversify supply chains to Southeast Asia.
Southeast Asian states are also eager participants of free trade agreements (FTAs), which add to their advantage. The ASEAN Free Trade Area (AFTA), established in 1992, currently comprises ten Southeast Asian states (except East Timor). It aims to eliminate both tariff and non-tariff barriers to transform the region into a production base. ASEAN has also signed bilateral FTAs with major partners such as China, Japan, South Korea, the US, Australia and New Zealand. Four ASEAN states (Vietnam, Malaysia, Singapore and Brunei) are members of the high-standard Comprehensive and Progressive Agreement for Trans-Pacific (CPTPP), while the entire grouping is currently negotiating the Regional Comprehensive Economic Partnership (RCEP) with other partners.
As a result, businesses, including high-tech giants, have started to flock to the region. Several of Apple's suppliers including Foxconn and Pegatron have expanded their production sites in Vietnam. Samsung, which has already established a strong presence in Vietnam, recently announced a major research & development investment in Hanoi. In 2019, multinationals like Sony, Harley-Davidson and Sharp Corp. also moved their production lines to Thailand. In June 2020, Indonesian President Widodo announced that Panasonic and LG Electronics would move part of their facilities to the island nation.
Relocation might be accelerated further with the assistance of governments. US lawmakers and officials are contemplating a ‘reshoring fund’ of $25 billion to encourage critical suppliers to move out of China. Japan earmarked more than $2 billion in subsidies for companies to either bring manufacturing back home or diversify supply chains to Southeast Asia. Along with India and Australia, the third-largest economy is also considering a 'supply chain resilience initiative' to reduce excessive reliance on China. Sensing the trend, Southeast Asian states are competing to attract companies considering supply chain diversification, in the form of investment incentives and tax exemption.
Critical bottlenecks
Nevertheless, while Southeast Asia can assume some parts of the global supply chains, it would be naïve to think the region can fully replace China as the next manufacturing centre. To fully comprehend Southeast Asia's challenges, one only needs to take a look at the 2019 Global Competitiveness Report by the World Economic Forum. In three critical aspects that determine the success in attracting foreign investments: quality human resources, transparent legal codes and infrastructure, Southeast Asia has a mixed record.
Regarding human resources, with the exception of Singapore, the other Southeast Asian states will have to invest more in education, especially critical thinking and digital skills, to significantly improve their labour force's quality. For example, in terms of skills, Vietnam’s labour force only ranked 93rd out of 141 countries, Indonesia’s 65th, Thailand’s 73rd and Cambodia’s 120th. In another ranking, the 2019 Total Workforce Index by ManpowerGroup, Singapore's workforce is considered world-class, with more than 50 per cent of its total workforce considered high-skilled with English proficiency at 83 per cent. At the other end of the spectrum, only 11 per cent of Vietnam's labour force is considered high-skilled and just 5 per cent enjoy proficiency in English.
The apprehension about Southeast Asian infrastructure is also triggered by its diversity in economic and social development. Again, Singapore is the top performer in both transport infrastructure (1st) and utility infrastructure (5th) out of 141 countries. Indonesia and Vietnam’s scores are on the average side, while Cambodia’s infrastructure need is emphasised through its low score. A baseline estimation by the Asian Development Bank showed that Southeast Asia needs $2,759 billion from 2016 to 2030 to cover its infrastructure need, an average of $184 billion per year. The lack of quality infrastructure is reflected in the fact that China has seven of the world's top 10 container ports, while Southeast Asia has just one.
Investment and business activities also need a conducive environment enabled by legislation. While Singapore is considered the best place for investors and businesses with top scores in public sector performance, transparency and property rights, Indonesia's performance is acceptable but it needs to improve its overall transparency. Cambodia and Vietnam are the worst performers in all three aspects, which will cause significant issues for both countries in attracting investors. Beyond mixed results in the quality of institutions, Southeast Asian states don't have a cohesive approach to legal frameworks governing investments. For example, investment law varies widely in number and function among states.
Alternative and realistic approaches
These mixed results are not at all surprising considering the region’s enormous diversity and lack of capacity compared to China. They show that the idea of a complete decoupling from China is unrealistic, as Southeast Asia is not in a position to fully replace China, nor can it overcome these structural issues in a short time. That being said, reshaping global supply chains to avoid excessive reliance on one particular country is still sensible and necessary. Geoffrey Gertz proposed a comprehensive and practical approach, which maps the current structure of supply chains within and across industries, identifies possible vulnerabilities and diversifies the network using a wide range of policies and international cooperation.
The focus is not to find China 2.0, but to make supply chains more resilient and diverse in order to insulate against endogenous or exogenous shocks. It will take more than just vague rhetoric and one-off policy decisions to achieve this goal.
DISCLAIMER: All views expressed are those of the writer and do not necessarily represent that of the 9DASHLINE.com platform.
Author biographies
Dr. Stephen Nagy is a senior associate professor at the International Christian University in Tokyo; a distinguished fellow with Canada's Asia Pacific Foundation; a fellow at the Canadian Global Affairs Institute (CGAI); and a visiting fellow with the Japan Institute for International Affairs (JIIA).
Hanh Nguyen received her M.A. in International Relations at International Christian University, Tokyo. Her research interest includes Vietnam's foreign policy and US-China relations. She is a fellow under the Japanese Grant Aid for Human Resource Development Scholarship (JDS). She has written for the Pacific Forum, 9DashLine, Geopolitical Monitor and the East Asia Security Centre. Image Credit: Unsplash/TimeLab Pro