International Finance
July-August 2019 Logistics Magazine

Trump trade war impacts Southeast Asian supply chain

Trump trade war impacts Southeast Asian supply chain
Trump’s escalated trade war with China is seeing manufacturing capacity move to Southeast Asia; but can Southeast Asia recalibrate its supply chain in time?

The trade dispute between Beijing and Washington has risen sharply after Chinese media reports said that Beijing will not cave into Trump’s trade demands with any more concessions. With that, attention is shifting to Southeast Asia as manufacturing companies accelerate the shift to the region or start sourcing from there. What does this trade war induced shift mean for the supply chain in the region? Are companies able to recalibrate their supply chains in time to meet US consumer demand?

China, often referred to as the factory of the world, is seeing companies re-shore their production to other Southeast Asian countries because of the fear of punitive Trump tariffs, if they continue to exporting out of the mainland. China’s exports to the US are more than four times the amount of US exports to China —and so, Washington has some credibility in asking for a rebalancing of bilateral trade.

The reality is that Southeast Asia has been the backyard of Chinese manufacturers for over a decade now. The region, therefore, has been part of the US-China supply chain for some time now.

Economists had anticipated this transition in supply chain to take place eventually with or without the trade war. The reason is that Southeast Asia had reduced its exposure to the West and has been working closely with the Chinese manufacturing companies since at least two decades. China’s industrial powerhouse Guangdong, for instance, is no longer the low-cost industrial hub it used to be because of rising wages and significant environmental changes.  

Southeast Asia has been part of the extended supply chain from China since early 2000s – the countries and companies in the region reduced their exposure to the west by working with the Chinese companies after the Asian financial crisis. Also, since the 2008 global financial crisis, the Chinese manufacturers have been establishing even more closer links through joint ventures or foreign direct investment in the region, driven primarily by rising labour costs in China and the need to diversify risks.

This means that Southeast Asia was a destination ready for the shift away from China,” Abhineet Kaul, director public sector and government consulting, Frost and Sullivan, Singapore told International Finance. The ASEAN China Free Trade Agreement in 2002 also helped in this trend brining average tariffs between Asean and China to under 1 percent. The trade war, in my opinion, has just accelerated the momentum towards Southeast Asia,” adds Kaul. 

Japanese companies check out

In light of Trump’s recent tariff threats, Japanese multinational Casio and print-maker Ricoh have moved part of their production from China to Japan and Thailand. This way, production capacity has moved to Southeast Asia from China.

US imports from China declined 13.9 percent in the first three months of 2019. Last year, the American Chamber of Commerce in China and the European Union Chamber of Commerce in China conducted two separate surveys which found that these tariffs could lead to an increase in production costs and a decrease in profits for businesses on the mainland.

Southeast Asia is poised to become the biggest beneficiary of the trade war according to Japanese investment bank Nomura. Importers in the US and China are sourcing goods from Southeast Asia and some parts of Northern America to dodge the punitive tariffs their governments have imposed as tit for tat on certain goods.

Nomura economists highlighted that Vietnam stands to benefit the most from trade diversion. Last year, the country’s largest export to the US was electrical machinery. Bloomberg in a report said that American exports from Vietnam increased 40.2 percent in the first quarter of 2019 compared to the previous year, pointing to the fact that it could supersede the UK as a US trade partner in the next few years.

Vietnam benefits from trade war

Vietnam’s foreign investments in the first quarter spiked by 86.2 percent to $10.8 billion and its GDP rose 7.9 percent as a result of increased exports to the US and China. Beyond the busy streets of Vietnam’s capital city of Hanoi, manufacturing units are making men’s garments for American brands such as Hollister, Bonobos, and Express. Also, Apple’s main assembler Foxconn is moving more of its production out of China by investing more than $200 million in India and Vietnam.

What is attractive about Vietnam is the low-cost labour, decent tax incentives, and close proximity to China. But, the Chinese manufacturers are struggling to recruit workers around Ho Chi Minh City and are forced to set up factories in the remote parts of the country, that are lacking in the necessary infrastructure and skill sets. Frost and Sullivan’s Kaul says that the rise in import tariff collection in the US indicates that companies have not been able to recalibrate their supply chains in time for the trade war, hurting both US importers and consumers as well as Chinese exporters.

“The top companies in China which had trade ties had invested to diversify their supply chain to Southeast Asia and to Mexico, Brazil, and parts of Africa, as the costs of labour was increasing in China. For example, one of the top bicycle companies in the US, Bicycle Corporation of America or BCA, a subsidiary of Kent cycles assembles frames imported from China from Shanghai General Sports in Kunshan. They had planned to import frames from Cambodia even before the trade war. However, while capital expenditure takes time, the rise in tariff hit businesses immediately,” says Kaul.

Guangdong vs Vietnam

China’s southern manufacturing base Guangdong has a population of 104.3 million, while Vietnam has a population of 95.5 million. This means that Guangdong has the capacity to draw migrant workers from the rest of China if necessary — which is not possible in Vietnam. Economists believe that the impact of the supply chain shift on Vietnam’s economy will be small but noticeable.

Southeast Asia is on the brink of a new economic cycle. The region’s lower-middle income countries such as Indonesia and Cambodia have a chance to grow because of the Trump Trade War.

Companies are incentivised to boost their production capacity in Cambodia because of its good investment incentives and tax exemptions. Luxury brand Steve Madden is shifting its production to Cambodia from China and will have 15 percent of its products sourced from its Cambodian plant this year.

Taiwanese electronics manufacturing company Pegatron has moved some manufacturing of networking gear to Indonesia, and the shipping has begun from the Bataam Island.

In recent years, Taiwanese manufacturers have been setting up manufacturing plants in different parts of Southeast Asia with the intention of diminishing their dependence on China as part of the government’s New Southbound Policy. “Laptop maker Compal has established production lines in Vietnam, Wistron has set up facilities in the Philippines, and Inventec in Malaysia.

Taiwanese companies that opened factories in China to manufacture electronics for American multinationals are moving their production back to Taiwan. These companies assembling devices from Chinese production bases have established a crucial link in the global tech supply chain because the likes of Dell and Hewlett Packard typically just slap their labels on the Taiwanese-made electronic goods.  Taiwan’s GDP increased 2.1 percent in the first quarter, according to Nomura economists.

Companies in China are also becoming aware of Malaysia’s electrical and electronic (E&E) sector which is the fourth biggest beneficiary of the trade war, particularly because the remaining Chinese imports comprises electronic products. Analysts have said that products from Malaysian companies in the semiconductor and chip-related industries might be in great demand as a result of trade diversion.

Another positive is that Malaysia is a fellow signatory to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), offering companies a preferential access to markets such as Australia, Canada, Japan, Mexico, and Indonesia.

Despite the migration, companies with an extensive manufacturing base in China will have to maintain a small portion of their capacity on the mainland.  

Companies will have to prepare themselves to make long-term, strategic decisions if Trump decides to impose another round of tariffs on Chinese-made consumer goods. Kaul explained that the challenge for those companies exists in two parts: The first part is regarding the investments from China into ASEAN and other part is about the exports from ASEAN into the US.

Although Southeast Asia is expected to benefit in the long run through trade wars and high investments in the region, limitations in foreign direct investments in some sectors will bring some challenges. Chinese investors will face behind-the-border barriers related to trade, such as logistics, licensing, and competition for skilled manpower with competitors from other East Asian countries.

For exports, some countries in Southeast Asia such as Singapore have free trade agreement with the US, but there is no ASEAN-US FTA. This means that the US can raise tariffs on select Southeast Asian countries in an effort to ‘punish’ them for accepting Chinese investments and for being a back-door to the US market, says Kaul.

“What the trade wars indicate is that the status quo is no longer accepted and that tariffs can be used as a tool for war to ‘punish’ countries for issues not related to trade. This is uncharted territory for humans since the first time humans bartered to trade,”  concludes Kaul.

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