Diversifying Supply Chains ‘Go South’

Shifts in regional supply chains that began as a trade war between the United States and China are being hastened this year by the coronavirus pandemic. Broadly speaking, this will result in slowdown in offshoring to China and a redistribution of manufacturing foreign direct investment (FDI) to the Association of Southeast Asian Nations (ASEAN).

It is common consensus that the ASEAN economy that stands the most to gain is Vietnam, with its youthful demographics, steadily growing population of 97 million, competitively priced labor force (particularly in comparison with China) and trade-friendly policies (again, particularly in comparison with China). In the short term, other ASEAN nations that will benefit are Thailand and Malaysia, while, regionally, Taiwan is the other economy that is advantaged by evolving trends in global trade.

It is true that even all of ASEAN combined, with a population of some 647 million, cannot compare with China – the world’s second biggest economy, at least in terms of global GDP, and the world’s most populous market, with 1.3 billion people – but ASEAN competes significantly in ease of business and labor costs. Minimum blue-collar wages in Vietnam, for example, are one-third those of Guangdong Province, which was not so long ago referred to as the “factory of the world.”\

Slowly but surely

Taking a broad view, the ongoing shifts from China manufacturing have not been an overnight phenomenon. Taiwan, for example, has embraced its so-called “Go South” policies that have sought to disentangle the island market’s reliance on China for some two decades, shifting manufacturing to Vietnam and Cambodia, due to rising labor costs in China and concerns about data security and intellectual property risks, as well as political concerns about being too dependent on a neighboring market with a threatening military posture on Taiwanese autonomy.

At the same time, Taiwan is increasingly in favor as an FDI target. As recently as mid-October – and partly as a result of preferential trade policies initiated in Taiwan in 2019 – it was announced that 682 corporations – including 15 suppliers for electric car manufacturer Tesla – had invested in Taiwan to the tune of US$39.1 million.

Manufacture of all Google, Amazon and Facebook data servers has also been relocated to Taiwan.

Meanwhile, Taiwan manufacturing continues to go south. Pegatron, a technology partner with name giants such as Apple, Microsoft and Sony, is reportedly investing as much as US$1 billion in a manufacturing complex at Nam Dinh Vu Industrial Park in Hai Phong, northern Vietnam.

Arguably a go-south exodus is taking place. Taiwan’s Market Intelligence and Consulting Institute, a think tank, notes that China’s 90% throat-lock hold on the global laptop manufacturing market – just to take one example – is likely to be reduced to 40% by the end of the decade. This, according to the think tank, will be driven by Taiwanese manufacturers formerly based in China and the major beneficiaries of manufacturing diversification will be Vietnam and Thailand.

A global phenomenon

It is not only Taiwan that is at the helm of a manufacturing push into ASEAN that will diversify supply chains. The US, Japan and South Korea are all following suit to one degree or another.

Apple is already manufacturing its best-selling wireless AirPods in Vietnam and has carried out at least one on-site inspection with a view to having its iPhones assembled there – a decision that is reportedly on hold while possible Vietnam contractors ramp up capacity and improve conditions for workers. Until as recently as last year, all such Apple assembly and production took place in China.

Google has shifted the manufacture of its Pixel smartphones from China to Vietnam, and the Pixel 4A and Pixel 5 will be produced there. VinSmart, a subsidiary of Vingroup, has reportedly received a contract to manufacture 2 million smartphones for a major, but as yet unnamed US carrier at the Hoa Lac Hi-Tech Park in Hanoi.

Samsung has wound down all smartphone manufacturing and assembly in China in favor of Vietnam and India, while some 90 Japanese companies have cleared hurdles making them eligible for subsidies provided by Tokyo to either relocate back to Japan or to shift production to Southeast Asia.

None of the above signal that the regional manufacturing and supply-chain landscape is about to see overnight tectonic changes, but it is evidence that an order that has been in place for some two decades is poised for major change. It will not be easy to displace China as the region’s dominant manufacturing hub, given its tested strengths, but the first moves towards doing so have been underway for some three years and they have been given added momentum by the Covid-19 pandemic crisis, which most experts agree will give rise to less concentrated manufacturing hubs and more diversified supply chains.

Some experts conjecture that manufacturing and supply-chain diversification could culminate in two or more supply chains – one for the massive China market and others for regional and global markets. But in the meantime, it should be noted that China continues to hold a commanding lead on manufacturing and supply chains.

As recently as June this year, a European Chamber of Commerce Business Confidence Survey revealed that 65% of its members still rank China as one of three top destinations for investment.

The report stated: “China will take heart that while some low-cost manufacturing activities continue to shift to other geographies, in certain areas where China has a strategic focus, such as the energy, mining and infrastructure equipment space, they are actually gaining export market share, in part fuelled by the Belt & Road Initiative.”

Reform and prosper

Such assessments should be seen as interim outlooks. Viewed from a wider perspective, forces are at play that will inevitably provide opportunities for rising “demographically rich” economies, especially those that open up and reform to attract foreign investment.

China is indeed a vast domestic market, but its overall trend is one of decoupling from global markets as opposed to opening up; its demographics are poor (China ranks 159th in terms population growth country rankings) and labor costs, as noted above, are increasingly expensive.

Returning to ASEAN, Vietnam leads the Southeast Asian pack not only due to its youthful demographics and relatively low labor costs, but also because the government is actively implementing reforms to attract investment.

First signed in March 2018, for example, in September 2020, the Vietnam government put Resolution No 23/NQ/TW into action. The plan lays out industrial policy until 2030, with an overriding vision reaching until 2045, with a focus on value-added, exports and job creation in the food, textiles and footwear, electronics and automobile sectors. Government policy is also focused on infrastructure, human resources and technology: The Ministry of Planning and Investment has released a draft strategy for the latter that embraces a national program to transform Vietnam into a “digital society” over the next decade.

The fact is that other ASEAN economies are positioned – at least in terms of demographics and labor costs – to make similar moves. Indonesia, the Philippines and Thailand are populous, inexpensive potential investment targets, but political bottlenecks to implementing reforms currently render them vulnerable to massive changes taking place as a result of the shifting relationship between China and the West – and due to the unique challenges presented by the pandemic crisis.

Time will tell whether the region in general can follow the lead of the two economies – Vietnam and Taiwan – that are taking crisis as an opportunity. Opportunities abound, but they will need to be seized.