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In the past decade, China has continually gained influence in Southeast Asia (SEA). This was the top finding of a recent survey published by the Center for Strategic and International Studies (CSIS) studying the views of “strategic elites” in SEA on a range of geopolitical issues pertaining to the future of the Indo-Pacific. The survey has identified China to be a stronger economic influence than the United States (US) in the region currently, noting that “[the] gap is expected to grow in the next 10 years.” Unsurprisingly, with US-China tensions intensifying in recent months, the defining geopolitical concern for each SEA capital has been found to be the direct and indirect effects of the strategic competition between China and the US, with the exception of Vietnam and the Philippines, whose respondents cited the possibility of conflict in the South China Sea as their top concern.
However, the outlook for SEA may not be all that negative. In light of new trade tariffs enacted by the US and Chinese governments against each other, rising labor costs in China, and uncertainties brought about by the COVID-19 pandemic, businesses have inadvertently begun looking outside of China to diversify their supply base and better insure itself from geopolitical risks. This has included relocating supply chains away to SEA, a region hailed by many as the most viable alternative to China. As a result, several SEA countries have found themselves enjoying new economic opportunities that were once unavailable to them.
In this article, we delve deeper into the reasons and consequences for the relocation of supply chains and manufacturing operations to SEA, and analyze the broader implications of this trajectory.
China has always been the ‘world’s factory’. However, recent US-China tensions have exerted an upward pressure on tariffs between the two countries’ exports. This has placed Chinese goods in a disadvantageous position, and has prompted China-based firms to reassess their supply chain strategies and search for new markets.
In 2019 alone, more than 50 multinational companies, including Apple and Nintendo, have shifted their production out of China to avoid the $200 billion worth of tariffs imposed on Chinese goods by the US government since 2017, Nikkei Asian Review reported. Apple, for instance, has called on its major suppliers to move about 15 to 30 percent of iPhone production outside of China.
In addition to foreign companies’ consideration to relocate their manufacturing bases, many local Chinese companies, including those who boast sizable market shares, have also recognized the disadvantages and risks of situating themselves in one country. While it is reasonable for these companies to keep their core manufacturing capabilities in their home country, they acknowledge the increased flexibility with which they will be able to adapt to geopolitical risks when they diversify their operations, and consequently, their risk and exposure. This has incentivized many Chinese companies to explore secondary manufacturing locations in SEA, such as Vietnam, Indonesia, Thailand and Malaysia.
In the webinar Southeast Asia — Why You Should Be Here Too, Beh Swan Gin, Chairman of the Singapore Economic Development Board, contended that economies of scale matter when companies face with the decision whether to relocate their supply chains. He acknowledged that while distributing manufacturing processes benefit certain industries, others are constrained by their scale of operation. The latter will instead focus on building a second supply chain that can provide resilience to the first. Mr. Beh also noted that while Vietnam has been an early winner there have been volumes of shifts to Thailand and Malaysia as well. As companies start to build new facilities and new capacity in these regions, other economies in the SEA region can stand to benefit as well.
According to Stuart Ross, the head of industrial for SEA at Jones Lang LaSalle (JLL), an America-based commercial real estate services company, though data for the year 2020 “will be distorted by the effects of the coronavirus on global supply chains”, he predicts that “the trend of manufacturing moving from China to Southeast Asia will continue” even after the COVID-19 pandemic subsides. If sustained, this shift could potentially open up new areas of economic growth for SEA countries.
Rising Labor Costs
Another factor contributing to a gradual relocation of supply chains is the increasing labor and production costs in China. As China gradually moves up the value chain, it loses its comparative advantage as the cheapest and most cost-effective manufacturer globally, especially for labor-intensive industries. Instead, the same product can now be produced at a lower cost in countries like Vietnam and Indonesia. The United States Fashion Industry Association’s 2020 Fashion Industry Benchmarking Study has identified ‘China plus Vietnam plus many’ to be the most popular sourcing model among respondents, as opposed to just ‘China plus many’. According to the study, “the typical sourcing portfolio today is 30-50 percent from China, 11-30 percent from Vietnam, and the rest from other countries.”
These results signify an increasing number of firms offshoring their production processes to more cost-effective countries in SEA, with Vietnam being the forerunner. In fact, this trend started as early as 2014. A cross analysis of the benchmarking studies from 2014 through 2019 tells us that US fashion companies have increasingly sourced for alternative destinations to China and have begun building a more diversified sourcing base since 2014. The worsening friction between the US and China has only pushed US fashion companies to further reduce their “China exposure”.
Furthermore, the Chinese minimum wage almost doubled between 2009 and 2014, resulting in thinner profit margins for firms, according to an article published by BillerudKorsnäs, a leading Swedish pulp and paper manufacturing firm. This reduces companies’ economic incentive to keep all of their operations in China, as by relocating to more cost-effective countries such as Vietnam, firms stand to benefit from wider profit margins.
Negative Sentiments Towards China
Escalating tensions between the US and China have undoubtedly exacerbated negative sentiments toward China around the world. Americans’ negative views toward China, in particular, have reached a “new historic high”, according to a report published by the Pew Research Centre in July. As a result, Chinese companies’ attempts at venturing into global markets have been met with apprehension and antipathy, with many governments citing national security concerns due to possible ties these Chinese companies might have with the Chinese central government.
Chinese company ByteDance, for example, has attempted to globalize with its video-sharing app Tiktok. Although Tiktok took off in several major economies such as the US, the Trump administration quickly threatened to ban the app from its domestic market entirely, arguing that the data security of Tiktok users in America could be threatened. In response, ByteDance sought to relocate its headquarters outside of China, in order to shake off its Chinese image. Recently in September, ByteDance announced plans to make Singapore its Asia headquarter.
ByteDance’s example highlights a shared concern by many Chinese companies in their global expansion. Recognizing the severity of pushback they might receive in international markets, some companies have identified SEA as a top contender to set up its regional or international headquarters, partly due to the region’s strong relationship with both the US and China, as well as its neutral stance even given the strained relationship between the two global powerhouses. Zoom, a popular video conferencing app which has recently faced scrutiny over possible data transmissions to China, also recently opened a data center in Singapore, in a bid to diversify its network in SEA and to disperse negative sentiments surrounding possible ties with China.
That said, firms are not abandoning manufacturing and other operational processes in China completely, and the world’s manufacturing hub is likely to retain its title for the following years to come. Although companies can likely enjoy cheaper labor and supply costs in countries like Vietnam, China’s deep manufacturing know-how, sophisticated supply chains and robust domestic market remain difficult, if not impossible for SEA countries to replicate.
Most countries in SEA are known to maintain neutral stances toward the US and China, for they benefit most from forging strong partnerships with both parties. Any further escalations in the US-China tensions might force them to pick sides, which would end up hurting their economies. Therefore, while certain doors have opened for SEA in the wake of escalating US-China tensions, some doors may shut in the long run as well.