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Alternative Production Bases in Mainland Southeast Asia (2) video

Rising production costs in China have hastened the search for alternative production bases, with manufacturers shifting attention to places in Southeast Asia, where their options are varied.

Logistics and Supply Chain Efficiency

Among the five countries in Mainland Southeast Asia, Thailand is the undisputed leader in transportation and logistics, thanks to its massive public investment, alongside continued MNC investment, in both the heavy and light industrial sectors over the past two decades (Thailand: ASEAN’s Key Logistics Hub). In the World Bank’s Logistics Performance Index (LPI), Thailand leads not only in terms of its total LPI score, but also on each of the six individual components, namely customs efficiency, infrastructure, international shipments, logistics competence, tracking and tracing, and timeliness [1]. Vietnam is a clear second in the league, leading Cambodia, Laos and Myanmar in each individual component. In the table below, the respective scores of Hong Kong are included for the sake of comparison.

Land-locked Laos fares better than Myanmar, with the latter a latecomer in opening up and adopting investment and trade reforms. For Laos, the building of the Greater Mekong Sub-region (GMS) transportation corridors has greatly contributed to intra-bloc and wider trade with the country. This has also helped Thai companies increase their manufacturing investment into neighbouring parts of Mainland Southeast Asia, a move prompted by escalating labour costs at home.

Table: Logistics Performance Index (LPI) and Key Dimensions
Table: Logistics Performance Index (LPI) and Key Dimensions

An influx of foreign-invested manufacturers, particularly in northern Vietnam, has steered the country’s industrial production towards higher-value goods, expanding both demand for and supply of logistics services. The south, traditionally the centre of manufacturing and trade, is home to Vietnam’s major container ports. Over the past decade, however, the northern region has become an increasingly popular destination for foreign manufacturers looking to diversify their production bases amid rising operating costs in China. The China-plus-one strategy adopted by a number of Japanese companies has also contributed to this development. Evidently, Vietnam’s logistics sector is only at an early stage in its development and needs to be further strengthened in order to underpin the country’s export-oriented manufacturing activities (for more on Vietnam’s logistics sector, please refer to these articles: Vietnam’s Logistics Market: Exploring the Opportunities and Overcoming the Challenges).

Land, Factory Rental and Utilities

In Southeast Asia, it is not unusual to encounter land ownership restrictions on foreign investors. Thailand, for example, restricts foreign ownership of land, with foreigners only allowed to have a leasehold interest in land, and leases and rentals arranged via negotiations. Under Thai law, the longest leasehold period is 30 years, although it is possible to renew such leases for the same length of time. Foreign companies can, however, form joint ventures with majority Thai ownership, which are then allowed to acquire land. Similar land ownership restrictions and leasehold arrangements are found in both Vietnam and Myanmar. [2]

Precise comparisons of land or factory rentals in different countries in Mainland Southeast Asia are difficult, as rental levels vary according to location and facility conditions even within the same province of a country. Many of the industrial parks (IPs) in these countries are outside the major cities, and factory rentals tend to be cheaper as a result. Generally, factory rentals are much more expensive in Thailand than in Vietnam or Cambodia. For example, factory rentals cost about US$6-7 per square metre a month in those Thai provinces not usually affected by floods, such as Chonburi and Rayong Provinces. In Vietnam’s Ho Chi Minh City, factory rentals cost about US$2.5-3.5 per sqm a month, while those in surrounding provinces within two hours’ drive time would typically costs half that. 

Stability of electricity supplies ranges from the best in the region, in Thailand, to the worst, in Myanmar, with Vietnam, Cambodia and Laos in between. A similar outcome is reported by the World Economic Forum (WEF) regarding the quality of electricity and telephony infrastructure of each country in Mainland Southeast Asia.

Table: WEF Index on Electricity and Telephony Infrastructure
Table: WEF Index on Electricity and Telephony Infrastructure

Import Tariffs and Free Trade Agreements

An important consideration in determining offshore relocation sites is the import duties charged on both materials and machinery needed in the production process. The table below shows the import tariff rates applicable to different product categories in different countries in Mainland Southeast Asia under Most-Favoured-Nation (MFN) treatments. For example, import tariffs on clothing range from about 14% to 30% for the four countries in the table, which also shows that import tariff rates on finished consumer goods are higher than the rates for input materials used in making those goods.

Table: MFN Import Tariffs of Selected ASEAN Countries (%)
Table: MFN Import Tariffs of Selected ASEAN Countries (%)

Notably, many foreign investors in those Mainland Southeast Asian countries are currently engaged in processing trade, and related production activities may be considered non-taxable transactions. In the case of Vietnam, raw materials imported for the production or processing of goods for export under contracts signed with foreign parties, goods temporarily imported for re-export purposes, as well as the transfer of technology, intellectual property rights, and computer software, are excluded from the country’s import levies.

Furthermore, many items imported into Mainland Southeast Asian countries are subject to rates under bilateral/pluralistic free trade agreements (FTAs), thereby enjoying rates better than the MFN rates shown above. For example, ASEAN has signed an FTA with China which has zero-rated most tariff lines for Chinese goods imported into Thailand and the four CLMV countries [3] [4].

Aside from tariff rates and treatments for goods imported into Thailand and CLMV, duties levied by importing countries on their final products are also a prime consideration. Among the five countries, Thailand has secured or negotiated the greatest number of FTAs (a total of 22, including those signed with China, Japan and Korea, in addition to deals being negotiated with the US and EU), followed by Vietnam (16), Myanmar (11), Laos (11) and Cambodia (9). [5]

Unlike Thailand and Vietnam, Cambodia, Laos and Myanmar are classified as least developed countries (LDCs) and are given special market access privileges under the Generalised Scheme of Preferences (GSP) [6]. Notably, Cambodia, primarily a garment-dominated exporting country, has received tariff-free and quota-free treatment under the GSP from both the EU and US, while Myanmar has yet to receive any GSP benefits from the US.

Table: GSP Beneficiaries for LDC Countries in Mainland Southeast Asia
Table: GSP Beneficiaries for LDC Countries in Mainland Southeast Asia

As previously noted, Vietnam has witnessed a sharp increase in exports thanks to substantial foreign investment in the country’s manufacturing sector (which accounts for about three-quarters of FDI). This is also closely related to its increasing number of FTAs with developed countries. Vietnam negotiating trade deals such as the EU-Vietnam FTA and the Trans-Pacific Partnership (TPP) is helping to attract more and more foreign manufacturers and associated supporting industries to the country. TPP, which is being negotiated by many Pacific Rim countries, is being driven in particular by the US, with a possible conclusion expected by the end of 2015. Meanwhile, some Hong Kong textile and garment companies have recently moved into Vietnam, partly motivated by the anticipated future market access benefits (for analyses of TPP, please read The Trans-Pacific Partnership: Impacts upon Hong Kong, the Chinese Mainland and the Global Economic Landscape).

When these FTAs are concluded, Vietnamese exports to the major developed markets of North America and Europe will enjoy considerably reduced tariffs (US duties on many of Vietnam’s exports of garments and shoes could be slashed to zero from between 7% and 32%, for example), further enhancing the competitiveness of Vietnam’s exports in developed markets. The US is Vietnam’s biggest export market (US$29 billion), covering about 20% of the country’s total exports and about half of its garment exports. Garment shipments from Vietnam to the US alone are expected to increase by 12% over 2014 to reach US$11 billion in 2015.

Industrial Relations, Observations and Conclusions

Myanmar: A wide range of economic reforms introduced by the civilian government since 2012 has raised the economic prospects of Myanmar, brightening up both investment and export outlooks amid the easing of international sanctions. Despite keen interest from foreign companies hoping to invest in Myanmar’s manufacturing sector, new provision of factories and industrial estates in Yangon is negligible and slow in coming, with rentals consequently increasing rapidly. Foreign manufacturers considering relocation to sites outside the city also need to take into account the poor transportation and logistics setup in much of the country, and in particular the highly unstable public power supply.

Wages in Myanmar are fast rising to catch up with those of neighbouring countries such as Cambodia and Vietnam. The Myanmar government announced in July 2015 a minimum wage of US$3.2 per day following a year of consultations with unions and employers. However, reports of garment worker protests have become increasingly common. With more than three times the population of Cambodia but garment exports that are less than a third of that country's, Myanmar has yet to live up to its potential as an emerging, alternative production base within CLMV. Meanwhile, most garment exports from Myanmar go to Japan and Korea. It will probably take a granting of GSP access to the US market to bring in more buy orders from international brands and give Myanmar’s garment exports a real push. Political reforms and presidential elections in late 2015 may, however, have a bearing on such developments.

Laos: The country intends to rebalance its export mix, raising the proportion of manufactured goods relative to agricultural products and commodities. However, Laos’ garment manufacturing sector has been suffering from an acute shortage of labour despite the continued export increase, with the government hiking the minimum wage by 44% in April 2015. Workers protests are seldom reported.

The land-locked country relies heavily on imports of fuel and the raw materials needed for its garment manufacturing. Many garment factories in Laos are operated by Thai investors, who also own factories in other locations like Vietnam and Cambodia. In short, the relatively low operation costs in Laos are to an extent offset by low productivity, not to mention higher transportation costs for shipping finished products outside the country.   

Cambodia: Despite being a mid-sized garment exporting country, Cambodia lacks a strong textile manufacturing base, and most of its textile fabrics and accessories are from mainland China, resulting in persistent trade deficits with the latter. Its total trade deficit has also been increasing over time despite the expansion of its garment exports. Meanwhile, despite an increase in the monthly minimum wage from US$100 to US$128 in January 2015, labour unrest demanding substantially higher wages continues and will make it difficult to retain a considerable wage differential edge over Vietnam.

Cambodia has the least number of FTAs among the five countries in Mainland Southeast Asia, but its garment exports are aided by GSP privileges conferred by both the EU and US. Further, a delayed economic recovery in Europe may cast a pall on Myanmar through reduced orders from international brands. Over the medium to long term, there are also risks that Cambodia may receive less preferential economic treatment in future, as it becomes more developed and graduates from GSP. All of this could cloud the outlook for manufacturing plants being relocated to Cambodia despite its relatively low operating costs among CLMV countries for the time being.

Vietnam: The country has developed the transportation infrastructure and logistics facilities of a fast developing, modernising economy to a far greater extent than either Cambodia or Myanmar (both LDCs), with more roads paved and many new industrial parks being built. Wages are somewhat higher than those in either Cambodia or Myanmar, though considerably lower than Thailand’s. An increased number of industrial parks around the country offer greater relocation choices for foreign manufacturing companies.

Rising production costs and a decreasing labour supply in China have prompted many mainland Chinese companies to relocate to Vietnam, especially northern Vietnam, which offers connectivity from both land and sea. Workers are in plentiful supply, especially in the Red River Delta areas. Although labour strikes are not unheard of in Vietnam, they do not cause much disruption to factory output on the whole. Despite a brief round of anti-Chinese protests triggered by territorial disputes in May 2014, overseas investors, particularly MNCs, have remained confident in the overall prospects for the Vietnamese economy, with newly registered FDI rising about 10% to US$15.6 billion in 2014.

Thailand: The country is the business and commercial hub of Mainland Southeast Asia, ranking way above CLMV in the World Bank’s Ease of Doing Business Index. As the most developed transportation and logistics hub in Mainland Southeast Asia, Thailand has been a mainstay for many MNC manufacturers, churning out an enormous amount of high-value electronics and automobiles for global supply chains. Thailand’s exceedingly low unemployment, coupled with a larger proportion of trained and technically competent workers, has driven up wages.

Due to the country having much higher wages than its neighbours in CLMV, many Thai companies are relocating labour-intensive manufacturing to those countries.

Thailand is also accelerating the planned construction of industrial estates inside several special economic zones (SEZs) in border areas. These include SEZs in Chiang Rai and Tak (in Mae Sot district), both of which border Myanmar. Despite a military coup in the country in May 2014, Thailand continues to maintain an open economy, and the interim government launched a new investment incentive policy in January 2015, offering preferential benefits to entice investment in higher-tech projects.

Photo: An assessment of production bases in Indochina for Hong Kong manufacturers

Rising production costs in China have hastened the search for alternative production bases in Indochina, where choices are varied. Thailand may appear a good option because of premier physical and business infrastructure, yet its appeal for labour-intensive manufacturing is fast diminishing against that of Vietnam, a rising star in Indochina. Cambodia and Myanmar appear to be more viable options than Laos, though the former two are not without their own challenges. Please click here to download the PowerPoint.

[1]  The LPEI consists of six components, namely (i) efficiency of customs and border management clearance (“Customs”); (ii) quality of trade and transport infrastructure (“Infrastructure”); (iii) ease of arranging competitively priced shipments (“international shipments”); (iv) competence and quality of logistics services — trucking, forwarding, and customs brokerage (“logistics competence”); (v) ability to track and trace consignments (“Tracking and tracing”); and (iv) frequency with which shipments reach consignees within scheduled or expected delivery times (“Timeliness”).

[2]  In 2010, a Cambodian law was enacted to allow foreign ownership of property above the ground floor of a structure. The law stipulates that no more than 70% of a building can be foreign-owned.

[3]  CLMV countries refers to Cambodia, Laos, Myanmar and Vietnam. They are late-comers in joining ASEAN and agreed to a longer tariff reduction schedule than its six founding members when negotiating ASEAN’s FTA with China.

[4]  The tariff reduction schedule for the China-ASEAN Free Trade Area can be found at http://www.asean.org/communities/asean-economic-community/item/asean-china-free-trade-area-2

[5]  The Asian Development Bank (ADB) tracks Asian integration through its Asian Regional Integration Centre (ARIC). There are more than 270 FTAs on its database. http://aric.adb.org/fta-country

[6]  The 2015 list of GSP beneficiaries has been released by the United Nations Conference of Trade and Development (UNCTAD): http://unctad.org/en/PublicationsLibrary/itcdtsbmisc62rev6_en.pdf

Content provided by Picture: Dickson Ho
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