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The search for low-cost production bases in Southeast Asia

Over the past decade, China has come to be regarded as the undisputed global workshop for making a plethora of finished goods for global consumption, especially in the G2 markets of the US and the EU. This has been helped, in no small measure, by the rapid economic development of China following its implementation of its big bang economic reforms in line with the country’s accession to World Trade Organization (WTO) membership back in late 2001. As China phased in all of its liberalisation commitments to further open up its market to the world in the late 2000s, it concomitantly inspired increased confidence among multinational corporations (MNCs) as to increasing their China-bound investment as well as to relocating a portion of their production to the country. This resulted in a veritable transformation of China’s economy.

This has also catalysed the development in Asia of an integrated production base for the global supply chain. This has seen non-China Asia increasingly sending its intermediate goods to China for final assembly before shipping to overseas markets (i.e. the red line in the graph immediately below). This practice, in terms of export share, roughly doubled to about 16 per cent between 2001 and 2009.

Chart: Non-China Asia’s exports to US and EU, and to China (% of total exports)
 

As can be seen in the chart below, China’s exports of consumer goods accounted for some 30 per cent of overall export growth, compared to around five to 10 per cent in other Asian economies over the decade to 2009. On the other hand, those exporter countries were heavily engaged in the trading of intermediate goods, particularly those parts and components used in the production of electronic products, which underlines Asia’s growing intra-regional trade.

Chart: Contribution to export growth (% of total export growth, 1998-2009)
 

The past decade has witnessed a massive inflow of foreign direct investment (FDI) to China. This has all sought to take advantage of the country’s competitive production environment, particularly the improved talent and productivity of the Chinese workforce, as well as the increased sophistication of China’s industry clusters. FDI surpassed the US$100 billion mark in 2010, more than double the level of a decade ago. Productivity, measured by growth in per worker output, was also up on China, almost tripling in the decade to 2011. By comparison, Vietnam was the best performer in Southeast Asia, enjoying an output growth of about 50 per cent.

Chart: China's FDI (US$ billion)
 
Chart: Trends in growth in output per worker, selected Asian countries, 2000–2011
 

Rising Chinese wages and Rmb appreciation prompt relocation away from the Chinese mainland

Chinese workers can pride themselves as being among the most productive in East Asia, with their increased productivity being rewarded with rising pay over time. Aside from the increased wages of Chinese workers, manufacturing operational costs in China have also been exacerbated by a number of other factors, notably rising land and rental costs, and in particular the continued appreciation of the Renminbi (Rmb). The Chinese yuan has appreciated more than five per cent against the US dollar over the past two years (as shown in the chart below) and about 10 per cent since the beginning of the ongoing global financial crisis that struck in late 2008.

Chart: Movement of Rmb against US dollar
 

Economic rebalancing contributes to higher Chinese wages

Another contributor to fast-rising wage bills is the Chinese government’s economic strategy of structural rebalancing, a consequence of the global financial crisis reducing demand from developed markets. With exports fast declining, China responded swiftly with a series of remedial measures, including the introduction of an Rmb4 trillion stimulus package, as well as introducing a range of policies aimed at raising domestic demand and focusing particularly on boosting consumer spending. Nonetheless, workers’ wages in China have grown on average at an impression double-digit annual rate over the past few years.

The economic rebalancing of China, coupled with the government’s increased emphasis on industrial upgrades for higher-value production, has diminished China’s appeal as a location for low-cost, labour-intensive manufacturing. In this context, the all-too-well-known scenario of “China makes all” has gradually come under serious re-examination from a considerable number of foreign investors over the past couple of years.

China’s emphasis on spurring domestic consumption will likely continue, despite the onset of the financial crisis now being more than four years ago, the economies of many developed countries have yet to recover. The US, for instance, is experiencing a slow recovery following rounds of quantitative easing, while the EU remains overwhelmed with persistent sovereign debt problems. Among the major players in Asia, the new government of Japan is struggling to edge the country out of its decades-long deflationary spiral through aggressive monetary and fiscal measures.

Appeal of production in Southeast Asia on the rise

As the world’s factory, China will undoubtedly remain a dominant offshore production base for the foreseeable future. This is despite the fact that its appeal in the low-end manufacturing sector will continue to be weakened by rising Chinese wages, industrial upgrades and the unabated appreciation of the Rmb. This will be especially true for the many cost-sensitive foreign companies currently operating in China. The illustration below shows how the unit labour cost in China continued to increase rapidly from 2008 onward, despite the decline in external demand caused by the global economic downturn. Unit labour cost[1]  in China has undergone a much steeper climb than that in Southeast Asia’s other exporter economies.

Chart: Unit labour cost (in producing a single unit of GDP, indexed to the US=100)
 

While the minimum wage levels in China may appear to be in line with other ASEAN countries, such as Thailand and Indonesia, China’s average wage is a lot higher, often double the minimum wage. As an indication, the average wage in Southern China is already above US$400 per month, almost twice that in Thailand or Indonesia and triple the level in Vietnam. Apart from increased wages, China has also seen a number of its other operational costs rise, making basic manufacturing less attractive financially.

Table: Comparison of monthly wages in ASEAN and China (US$)
 

China has a labour force of more than 800 million, the largest in the world. It is more than double the ASEAN’s combined workforce of just over 300 million. The combined ASEAN workforce, though, is sufficiently large (and sufficiently skilled) to tempt foreign companies should they consider relocating some of their basic manufacturing away from China. In recent years, China’s pace of workforce expansion has slowed, increasing at no more than one per cent a year since the beginning of the global financial crisis. Over the same period, most ASEAN countries have seen their labour forces expand at a faster rate, on average double that of China.

Table: Labour force in selected Asian economies (millions)
 

ASEAN’s integration initiatives further enhance its appeal to FDI

ASEAN is economically diverse and geographically apart and it would be impractical to expect any massive level of migrant worker movements within the region each year, certainly nothing on the scale of that which occurs within China. Nonetheless, ASEAN has made great strides in terms of regional economic integration and the creation of a common market and a shared production base – the ASEAN Economic Community (AEC). It is hoped that, by the end of 2015, this umbrella organisation will transform ASEAN into a region characterised by a freer movement of goods, services, investment, skilled labour and a simplified flow of capital.

AEC initiatives encompass a wide range of co-operative areas, including enhanced infrastructure and communications connectivity, development of electronic transactions through e-ASEAN, as well as integration of industries across the region to promote regional sourcing. ASEAN, for instance, has been building a single window for customs and cross-border trade since the mid-2000s. This allows companies to make goods in one ASEAN location and then transport them to another country using a standard set of documents, without being subject to cumbersome procedures and trade barriers.

As integrated and efficient transportation networks are essential to improving ASEAN competitiveness, the ASEAN leaders adopted a “Master Plan on ASEAN Connectivity” in October 2010. This resulted in the introduction of a flagship infrastructure project – the “ASEAN Highway Network” (AHN) – intended to resolve road connectivity issues within ASEAN. Aside from the AHN, additional transportation networks are being built in order to connect with China. These initiatives include North-South Corridors (connecting Singapore, Malaysia, Thailand, Cambodia and Vietnam with China), the Singapore-Kunming Rail Link and the resolution of a number of existing connection shortfalls.

ASEAN has also designated 47 ports as the main ports of the trans-ASEAN transport network. Aside from airport development, ASEAN has also placed an emphasis on harmonising ASEAN air navigation systems, procedures and air routes in anticipation of growing air traffic in the region. In short, ASEAN has embarked on a string of infrastructure initiatives aimed at helping improve the competitiveness of its production networks, resulting in better trade and investment flows.

Map: Singapore-Kunming Rail Link networks and missing connections
 

Aside from manufacturing low cost items, such as in the flourishing garment industries of Cambodia and Vietnam, ASEAN has also become progressively more capable of handling more sophisticated manufacturing on an increasingly large scale. This is largely down to the growing availability of talented workers and the continual influx of FDI earmarked for higher-end manufacturing projects. This has seen Thailand emerge as an automotive manufacturing hub, with Indonesia also succeeding in attracting investment from abroad in the motoring sector.

In 2012, electronic products overtook garments as Vietnam’s leading export sector. This was largely due to increased output and exports for MNCs from the US and East Asia. Beneficiaries of this have included Samsung’s factory in the Bac Ninh Province, adjacent to Hanoi. This now produces more than 100 million smartphones and tablet units annually, amounting to an export value of US$12.5 billion in 2012. As part of a plan to expand its business and production capabilities in Vietnam, March 2013 saw Samsung begin the construction of its second industrial complex in the country. The new facility represents an overall investment of US$2 billion by the company and is based in Thai Nguyen Province, some two hours’ drive time from Hanoi.

While Thailand remains a key ASEAN investment target for Japan, despite the disruptions caused by flooding, Japanese companies have also stepped up investment in other ASEAN countries, notably Indonesia and Vietnam. This is largely in a bid to seek alternative production bases to hedge against their exposure in China. In the case of Vietnam, Japan’s inward FDI in the country doubled in 2012, despite an overall double-digit decline in net FDI inflows.

Concern over large-scale relocation away from China appears overblown

While some US companies are reportedly reconsidering onshore production in light of growing operating costs in China, others are planning to relocate production to Southeast Asia. Despite this, concerns over a wholesale relocation from China would appear overblown, especially taking into account Chinese workers’ higher productivity, the comparative sophistication of China’s industrial clusters and the country’s undoubted capacity to rapidly mobilise and utilise a large amount of workers to meet substantial international orders.

Although, as referenced earlier, China’s inward FDI surpassed the US$100 billion mark in 2010, this inflow decelerated somewhat in 2012. Despite this slowdown, FDI will likely remain robust in the years ahead, particularly those funds targeting China’s domestic market and the production of high-value exports, as opposed to those low-value products where manufacture is likely to be relocated to other regions.

Balance low-cost manufacturing in ASEAN with the considerations of the wider business risks

As in many other emerging markets, a number of ASEAN countries, despite boasting a low-cost production environment and attractively low wages, faces a number of shortcomings. Aside from general wage levels, there is a number of other relocation considerations, including land costs, the availability of skilled labour, utility costs, infrastructure concerns, the complexity and transparency of government regulations and uncertainties as to tax regimes.

A prime example of these additional concerns would be Myanmar. As a relatively undeveloped and recently emerging economy, it has the undoubted appeal of an average wage level less than half of that in Thailand or Indonesia. On the down side, its public electricity supply is limited just to five hours in the dry season.

The ASEAN-5 countries (Indonesia, Malaysia, Thailand, the Philippines and Vietnam) have all initiated a number of reforms aimed at optimising FDI inflows. These have centred on those trade and investment measures aimed at making it easier for foreign companies to start businesses, trade and enforce contracts. It is believed that these improvements will be seen as a clear response to longstanding calls for greater transparency in the administration of business regulations across all of these five emerging markets.

The World Bank currently ranks ease of doing business in 185 economies. These ratings are based on 10 individual criteria, including starting a business, dealing with construction permits, securing credit, protecting investors, access to electricity, registering property, paying taxes, trading across borders, enforcing contracts and resolving insolvency issues. If these figures were abstracted out for Asia, and China was adopted as the benchmark when considering relocation to an ASEAN-5 economy, it would appear that Vietnam is now closely behind China, with both Malaysia and Thailand also moving seemingly well out in front.

Chart: 2013 Ease of doing business ranking: selected economies in Asia
 

Looking more closely at the 2013 criteria-specific rankings, China falls behind the Philippines when it comes to securing an electricity supply, taking three times as long (i.e. 145 days versus 50 days). Although China was the world’s leading exporter in 2012, it is seen to be cumbersome to trade across its borders than it is in either Indonesia or the Philippines. The problems largely stem from Chinese regulations requiring more export documents than competing nations, thus considerably lengthening the lead time for exporters working in the country.

Table: 2013 Rankings of easing of doing business: getting electricity
 
Table: 2013 Rankings of easing of doing business: trading across borders
 

Given ASEAN’s economic diversity and its growing capacity, across the board, for handling sophisticated production of an expanding scale, it seems likely that no one ASEAN country will be the solitary beneficiary of any mass industrial relocation from China. Overall, much will depend on the exact requirements of the production facilities being relocated, as well as the perceived ease of doing business in any given ASEAN country. Despite this, Vietnam looks set to have considerable appeal, given its comparatively low wage costs and its reliable labour supply.

With all the focus on facilities being relocated from China, it should be remembered that there are already signs of existing ASEAN-based industrial operations considering a move from one of the region’s countries to another. In particular, there have been reports indicating that a number of Thai-based garment companies are considering relocating their plants to Myanmar. These developments have been fuelled by Thailand’s adoption of a daily minimum wage of about US$10 as of January 2013.

 


[1]  Unit labour costs (ULC) measure the average cost of labour per unit of output and are calculated as the ratio of total labour costs to real output.

Content provided by Picture: Dickson Ho
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