By David Born

Southeast Asia is suddenly back on everyone’s lips. Impressive growth figures have earned it a notable place among the fastest growing regions in the world. More importantly, ASEAN has also become a focus in the geopolitical debate. Some observers believe that Southeast Asian countries could not only benefit from multinationals hedging against escalating geopolitical frictions but also that the region will increasingly become the new manufacturing hub of choice. Our new Roland Berger Institute Quarterly gives a reality check to this consideration.

It quickly becomes apparent that the region has already been an attractive destination for export-oriented foreign direct investment (FDI) long before the Covid-19 crisis. Southeast Asian countries moved up the ranks as companies were adjusting for higher costs of doing business in China. The increase of US tariffs on Chinese imports from 2018 onward and further signs of a decoupling of trade also played a crucial role.

But it’s not just the US that is increasing imports from the region. China, too, is buying more goods from Southeast Asia while its imports from the US are stagnating. Notably, a growing share of FDIs to ASEAN is now directed towards the manufacturing sector.

A number of structural changes favor the shift to ASEAN supply chains. For instance, as China is moving up the value chain, cost advantages are disappearing. Labor is no longer as cheap as it was in the past. Since 2013, Chinese manufacturing wages have doubled to an average of USD 8.27 per hour. This rise stands in stark contrast to hourly manufacturing wages in Vietnam, Thailand or Malaysia which remain below USD 3 – and lower wages are not the only advantage the region can claim. Singapore is gaining ground in financial services and high tech. At the same time, Southeast Asia can draw on an impressive number of people aged between 25 and 54 with a tertiary education.

However, a focus purely on cost disparities distorts the picture, as the gap in productivity is still significant. The fact remains that most Southeast Asian countries cannot compete with China’s output per worker. Historically, Malaysia has been an outliner, but even there, productivity growth stagnated largely during the last years.

The lesson for companies in search of supply chain alternatives therefore is twofold: First, they need to analyze how lower production cost equates to a reduced productivity rate. And second, they need to assess if it is possible to address the productivity challenge over time with on-the-job training and improved infrastructure. The latter matters greatly, as some of the Southeast Asian cost advantages are likely to shrink over the next decade.

What makes the ASEAN supply chain so special?

Similar to its northeastern neighbors, ASEAN countries choose FDI-driven industrialization and can be categorized into 3 groups. Tier-1 is Singapore acting as the technology node. Tier-2 is ASEAN-4 (Malaysia, Thailand, Indonesia and the Philippines) as newly industrializing economies with a mixture of competitiveness. And Tier-3 is CLMV (Cambodia, Laos, Myanmar and Vietnam), which is attractive for companies looking mainly for cost reduction.

ASEAN supply chains are also deeply integrated with Northeastern Asian neighbors. Economists usually use the flying geese pattern to explain the labor division in the region, with Japan as technology leader vis-a-vis newly industrializing economies and developing countries. In maximizing each economy’s competitiveness regarding cost and technology, the frequent cross-border transportation of a good during its production life cycle in the network of multinational enterprises (MNEs) leads to vibrant regional supply chains.

In the new RBI Quarterly, we will take a deep dive into the electronics and automobile industries – the main drivers of the regional merchandise goods exports – to illustrate the nature and trends of the alternative Asian value chain. Although the archetype textile and clothing industry is more conspicuous due to their consumer goods character, it mainly concerns CLMV (Cambodia, Laos, Myanmar and Vietnam) and accounts only for a small portion of their exports.

Because of its strong footprint in both the electronics industry and automobile production, ASEAN will play a bigger role in the re-configuration of global value chains with the goal of increasing supply chain resilience.

Due to integrated regional division of labor, we observe expansion of Japanese, South Korean and Chinese multinational firms as strong (and rotating) leaders – akin to the flying geese paradigm. However, the industry in the region is challenged by the conundrum of FDI-led industrialization that is mainly based on the technology input and supplier chain network of multinationals instead of competitive, indigenous companies.

Plenty of obstacles ahead

Southeast Asia will therefore certainly not replace China overnight as the world’s factory. For this to happen, its supply chains would need to become much more efficient and integrated. At present, commerce between ASEAN countries still faces too many obstacles. On the one hand, a lack of quality infrastructure inhibits a seamless flow of goods from the outset. On the other hand, essential regulation and legal agreements between countries are lacking as regional disputes and national ambitions stand in the way of beneficial consensus.

Additionally, the strong dependence on Chinese goods poses an additional impediment to the region’s ability to become the new global workbench. Likewise, the transition to a low carbon emission economy presents a major challenge for Southeast Asia. If not achieved fast enough, the region’s competitive advantages could dwindle rapidly.

Instead of a full trend reversal, we rather expect de-risking production strategies gaining further momentum, whereby a growing number of multinationals will reduce their exposure and start building up supply chain roles in Southeast Asian countries. As a natural outcome of this process, a growing share of the global value chain would almost automatically move to the region – and might help Southeast Asia to recreate the conditions that made China the world’s production powerhouse.

We thank Yu Wang for her contributions to this article.