Southeast Asia's Future Growth: Who Will Lead the Way?

Linda Y.C. Lim
University of Michigan Business School

Southeast Asia’s past economic growth was based on high rates of savings and investment, macro-economic stability (low inflation), and relative openness to international trade and investment. The region was especially known for the foreign-direct-investment-led export of primary commodities and labor-intensive manufactures to world markets. In manufacturing especially, it formed part of the regionally-distributed global supply chains of multinational corporations e.g. in garments, footwear, electronics and computer equipment.

Note that other Asian economies—esp. Japan in the 1980s and the newly-industrialized economies of Taiwan, S. Korea, Hong Kong and Singapore in the 1990s—accounted for the majority of this foreign direct investment. But the exports produced went mainly to western markets in the U.S. and western Europe.

Southeast Asia’s economic growth has slowed down since the financial crisis of the late 1990s, going from 8% a year to 4-5% a year growth in real Gross Domestic Product. This slowdown is the result of (1) weak external demand due to a slowdown in the global economy, especially the tech bust in the U.S., and (2) low domestic investment due to incomplete financial and corporate restructuring and reform following the financial crisis (continued debt overhang, excess capacity etc.). Thus there has been a decline in both foreign and domestic investment. Economic growth has been kept going by domestic consumption, and by government deficit spending (which cannot go on forever).

China’s role in Southeast Asia’s slower growth has been much exaggerated, at least with respect to foreign investment diversion to date.

First, China’s share of global FDI is not disproportionate to its share of global GDP and exports. In 1988-90, China accounted for the same proportion of global FDI as it did of global GDP. By 1998-2000 its share of global FDI had risen but was still only 1.3 times its share of global GDP. In contrast, in 1988-90, Singapore’s share of global FDI was 12.7 times its share of global GDP, and by 1998-2000 this had declined to 2.2 times—still much more disproportionate than China’s share. Malaysia’s share of global FDI fell from 4.3 times its share of global GDP in 1988-90 to 1.6 times in 1998-2000—again, greater than the same ratio for China (1.3). In short, China receives a lot of FDI because it is a very big country. It is some of the ASEAN countries, notably Singapore, Malaysia and Thailand, which have received disproportionately large amounts of FDI relative to their size, and this was still true of Singapore and Malaysia in 2000 (UNCTAD 2001).

Second, it is Hong Kong and Taiwan, not foreign countries, which account for over two-thirds of the ‘FDI’ going to China. Strong FDI growth in China in the 1990s was due largely to increased FDI from its own territory, Hong Kong, more than 25% of which is estimated to be “round-tripping” investment from China itself.

Third, developed countries have been investing more in Southeast Asia than in China. Between 1996 and 2001, the average annual FDI outflow from Japan to the ASEAN-5 was US$4b a year, compared with only $1.5 b invested in China ($2.3 b in Greater China, including Hong Kong and Taiwan). The U.S. invested $4.3 b in the ASEAN-5 compared with only $1.4b in China ($4.6 b in Greater China), while the European Union countries of Britain, France, Germany and Netherlands invested $3.5 billion annually in the ASEAN-5, compared with $1.5 b in China ($1.8b in Greater China). (Wu and Puah, 2003)

Looking forward, developed countries will invest much more in China but this does not necessarily mean that they will reduce investments in ASEAN. For example, an October 2001 survey of Japanese multinationals showed that 21% of companies surveyed planned to move existing production to China, but 67.5% would move from Japan to China, and only 6% (of the 21%) would relocate from the ASEAN-4 (cited by McKibbin and Woo, 2002). Developed countries will continue to invest in ASEAN even as they increase investments faster in China because

(1) Some ASEAN countries continue to be cheaper than China for some export-oriented investments e.g. in agriculture, raw materials, labor-intensive manufacturing (e.g. Vietnam).

(2) Companies will second-source to diversify country risk in their supply chains.

(3) FDI in ASEAN countries may be more profitable than in China e.g. the rate of return on US FDI in China in 2001 was 12.4%, while in Indonesia it was 15.2% and in Malaysia 17.2% (US DOC 2002).

(4) The ASEAN regional market itself is growing, faster than the rest of the world except China and India, and is not small (see below)

(5) The proposed ASEAN-China FTA means the China market can be supplied from ASEAN as well as vice-versa. It will increase ASEAN GDP growth by 0.9%, and China’s growth by 0.3% a year (McKibbin and Woo, 2002)

Still, Southeast Asia’s future growth will depend heavily on its Asian neighbors, esp. China.

(1) China is near by, is already the world’s third largest economy, and is growing 3-4 times faster than the region’s traditional western trade partners and Japan.

(2) China is the region’s fastest-growing trade partner and foreign investor, with ASEAN’s trade surplus widening and expected to persist (e.g. McKibbin and Woo, 2002)

(3) There are many economic complementarities between China and ASEAN e.g. ASEAN is much more cost-competitive than China in agriculture and some raw materials, and China is already the largest and fastest-growing source of tourist revenue for ASEAN’s large tourist sector.

(4) Even without a China-ASEAN FTA, the fall of China’s trade barriers following its entry into the WTO will create more market access for ASEAN exports, and give ASEAN-based industries (including foreign-invested industries) greater economies of scale. The China market can be supplied from ASEAN as well as vice versa (e.g. Thai-made pick-up trucks).

(5) Southeast Asia’s Asian neighbors are less vulnerable, and less risk-averse, with respect to terrorism, than are western countries e.g. Bali’s tourist revival has been due to a surge in Asian visitors.

What about Vietnam?

Most foreign investment in Vietnam already comes from its Asian neighbors esp. fellow ASEAN members like Singapore and Thailand. This will continue since Vietnam’s comparative advantage lies in agriculture and marine products, and labor-intensive manufactures, some of which are being relocated from higher-cost ASEAN neighbors as they climb up the technology ladder. Energy, finance and software may see some western (or Viet Kieu) investment.

Vietnam’s tourist sector will also continue to be dominated by arrivals from other Asian countries. Vietnam may also have an advantage in attracting western tourists as it is non-Islamic and perceived to be “safe”.

Even if external forces are favorable, Southeast Asia must lead its own future growth by

(1) Completing financial sector reform and developing capital markets to channel the region’s high savings into productive investment for domestic consumption as well as exports.

(2) Investing heavily in education and human capital to accelerate the move up the value chain as low labor cost advantage is lost (as it should be).

(3) Accelerating regional integration via AFTA etc. to create a single regional market that can attract investment, and benefit from scale economies and dynamic competition. Combined together, the ASEAN countries are not small. They have 40% of China’s population, more than half of China’s GDP (and 20% more than India’s), and 150% of China’s exports (10 times India’s).

(4) Getting governments out of business to reduce regulatory inefficiencies, release resources for the domestic private sector and to spur local entrepreneurial dynamism as an engine of growth.

(5) Making themselves good places to invest for both domestic and foreign capital by e.g. ensuring macro-economic stability, securing property rights, developing strong independent judicial systems, and good corporate governance and risk management regimes based on transparency, accountability, and the free flow of information.