Capturing the gains of supply-chain diversification

Often coined “the factory of the world”, China is a key player in the complex, intricate web of global value chains. However, rising wages over the past few years, followed by the US-China trade war, had prompted the need for supply-chain diversification. Many firms began looking for a “backup” to Chinese manufacturing, adopting the China Plus One strategy.

The pandemic has hit supply-chains on an unprecedented scale. The initial outbreak in China had devastating impacts on manufacturing, resulting in factory closures and millions of job losses. Due to the interconnectedness of global supply-chains, this crash had ripple effects on businesses around the world.

Shortages of intermediate parts, coupled with suspensions of logistics systems, transport and in-person work from lockdown measures meant that the electronic, pharmaceutical, automotive and countless other industries incurred significant losses. The tremendous impact from China’s slowdown alone has prompted a second wave of supply-chain relocation, in an effort to establish alternative manufacturing hubs. According to a survey by Gartner, a third of companies engaged in global value chains plan to relocate from China by 2023.

So where will these factories relocate to? On the surface, ASEAN appears to be the logical option. The region’s relative geographic proximity and strong trading ties with China, where many core supply-chain processes will still remain, as well as the prospect of a single market, makes it an attractive choice. ASEAN states also stand to massively benefit from further involvement in global value chains. The United Nations Conference on Trade and Development (UNCTAD) estimates that foreign direct investment (FDI) flows to developing Asia will fall by up to 45% in 2020 alone, hence being at the receiving end of this second wave of relocation might be a lifeline to ASEAN economies.

The Center for Indonesian Policy Studies (CIPS) recently hosted a panel discussion on ASEAN participation in value chains, featuring Lau Zheng Zhou from the Institute for Democracy and Economic Affairs (IDEAS), Dr. Jayant Menon (ISEAS) and Andree Surianta (CIPS). In his presentation, Lau raised the concern that unhealthy competition might emerge between ASEAN nations over attracting scarce FDI, due to pre-existing divergence in domestic policy.

For instance, Indonesia’s participation in global value chains has been shrinking due to complex, overlapping regulations on FDI. At the other extreme, Vietnam has demonstrated an increasing reliance on intermediate goods from non-ASEAN sources, with a greater proportion of its exports consisting of foreign inputs. Continuing along this trajectory, it is possible that Vietnamese exports will no longer qualify for preferential trade tariffs within ASEAN, ceasing to benefit from the zero-to-low tariffs between member states.

This has and will continue to result in lower regional integration. However, in order to capitalise on opportunities presented by the ASEAN market, multinational companies (MNCs) prefer to establish regional hubs in member states with substantial intra-ASEAN trade, particularly in those with liberal FDI policies. Thus inter-country competition for FDI will lead to further divergence between the member states, undermining the already dwindling ASEAN integration.

The goal of this second wave of relocation should be to raise the bar together – an equitable distribution of FDI inflows across the ASEAN member states. This is far more likely to occur with greater liberalisation and regional integration, preventing MNCs from discriminating between member states based on factors like government restrictions or accessibility to preferential trade tariffs.

In addition, the harmonisation of trade and investment regulations across ASEAN will not only make it more straightforward for MNCs to enter the market, but will also encourage the broadening of investments regionally – inducing spillover benefits for other member states.

But what is the current outlook for ASEAN integration? According to an IDEAS report tracking the progress of ASEAN integration, underlying historical structural characteristics and different development levels of the member states mean that there is an inherent lack of trade complementarity, driving down intra-regional trade. Furthermore, while tariffs have been virtually eliminated, the region continues to be held back by non-tariff barriers, which remain difficult to tackle due to domestic political and economic interests.

But slow progress is better than no progress. The Regional Comprehensive Economic Partnership (RCEP), a free trade agreement between ASEAN and five existing trade partners, is expected to be signed late this year, and is certainly a step in the right direction. If put into practice, there is a large incentive for member states to adopt more ASEAN-centric policies – making them better positioned to capture the gains of this partnership.

ASEAN integration remains a work in progress, requiring a great deal of coordination and reconciliation. ASEAN member states have to start recognising and accepting each other’s unique challenges, while maintaining an ongoing conversation regarding these domestic issues. This remains especially important given the varying effects of COVID-19 on each of the economies. But instead of looking at integration as an additional burden, ASEAN should embrace it as a source of recovery from the recent economic shock – enabling the second wave of relocation to raise the bar equally across member states.

Written by Natasha Tan, IDEAS’ Intern
First published in The Edge on 18 July 2020

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