Vietnam the big winner from China’s move up the value chain

BEIJING — China’s ongoing transition from low-wage manufacturer to budding high-tech hothouse is creating waves across the rest of Asia.

The biggest winner from the Middle Kingdom’s move up the value chain looks set to be Vietnam, while the biggest loser could be South Korea, at least if two recent reports are to be believed.

Korea’s problem is twofold. Firstly, as Chinese manufacturers have become more technologically proficient, they have started to produce more of the high-value intermediate goods that China used to import from advanced economies such as South Korea.

As Mr Gareth Leather, senior Asia economist at Capital Economics, notes, the proportion of China’s imports accounted for by intermediate goods has fallen from two-thirds in 2011 to 52 per cent, as of 2015.

Secondly, South Korea is a traditional exporter of many of the higher tech goods that China is now muscling in on. Over the past five years, Korean companies have lost market share to China in sectors such as mobile phones and flatscreen televisions, as the first chart shows.

Worse still, Mr Leather fears a far wider range of Korean exporters could be hit as China continues to develop its manufacturing prowess.

“So far, it has been mostly Korea’s electronics companies that have suffered, but this could start to change,” he warns. “Chinese car companies have been doing well in emerging markets, and could soon start to gain market share from Korean companies.”

“China is also rapidly gaining market share in the shipbuilding industry. In recent years it has gained market share at the expense of shipbuilders from Japan, and recently overtook Korea as the world’s biggest shipbuilder,” he adds.

Indeed, in the first quarter of this year, Chinese shipbuilders tightened their grip on the global market by winning almost half of new commercial ship orders, leaving South Korea trailing with a mere 7.4 per cent, according to Clarksons, a brokerage.

In theory, at least, Korean companies should be in a position to benefit from rising consumer spending in China, positioning themselves as exporters of premium consumer goods.

However, given that consumer goods currently account for just 3.4 per cent of South Korea’s exports to China, a figure that has actually fallen a fraction over the past decade, Mr Leather argues that “even a surge in Chinese imports of consumer goods would not make much difference to Korea”.

China’s growing competitive threat to South Korea is one of the reasons — alongside high levels of household debt, a falling working-age population and a lack of a meaningful government response — why Capital Economics believes the country will struggle to achieve economic growth of more than 2 per cent a year over the next decade.

The likely winners from China’s move up the value chain are low-end manufacturing centres that are increasingly picking up business no longer prized by China, such as in the textile industry. Capital Economics notes that in countries such as Bangladesh, Sri Lanka and Vietnam, the monthly salary of a factory worker is typically between US$100 (S$134) and US$200, a fraction of the US$420 or so in China.

Standard Chartered has developed this theme further with the latest iteration of its annual survey of manufacturers in China’s Pearl River Delta, a densely populated region encompassing cities such as Guangzhou, Shenzhen and Dongguan.

The 290 manufacturers surveyed expect, on balance, to see labour supply tightening further this year, continuing a recent trend driven by the peaking of China’s working-age population, despite the slowing economy.

Partly as a result, they expect to see wage rises of 7.7 per cent in 2016, on average, just a fraction below last year’s 7.8 per cent and the 8.1 per cent seen in 2014. Amid the economic slowdown, the respondents expect their margins to fall by an average of 6.1 per cent this year, a sharp deterioration from the 0.4 per cent margin contraction witnessed in 2015. Given this backdrop, 30 per cent of the 290 manufacturers told StanChart they wanted to move production elsewhere.

Shifting capacity elsewhere within China remains the favoured ploy, but only just, with 17 per cent of manufacturers favouring this option, down from 20 per cent last year and 28 per cent in 2014. However, 13 per cent said they favoured moving overseas, up from 9 per cent in 2013.

In particular they cited better labour supply (in terms of quantity and quality of workers) and the benefits of being within various free trade areas as reasons for favouring the overseas option, even if internal relocation is preferable in terms of tax incentives and the economic outlook.

Of those companies that are planning to export capacity, Vietnam has emerged as the clear favourite destination, followed by Cambodia, as the second chart shows. In contrast, the relative attractions of a phalanx of countries elsewhere in south-east and south Asia have dimmed.

These manufacturers typically expect to cut their costs by 20-25 per cent by moving overseas, with Bangladesh in particular seen as a cheap option.

However Vietnam, and to a lesser extent Cambodia, trounce their potential rivals in terms of labour supply, tax incentives, non-wage business costs, economic outlook, proximity to new buyers and customers and the trade pact-related benefits they can offer, as the third chart shows.

South-east Asia “is set to become the world’s next manufacturing hub, in our view, as China continues its transformation into a more services-oriented economy”, says Mr Chidu Narayanan, Asia economist at StanChart.

As well as the obvious benefits of a cheaper labour force, Mr Narayanan argues that South-east Asia’s strong economic growth and “rising middle class” offer manufacturers that opt to relocate there the opportunity to tap into a “large and growing” consumer market. “We believe Vietnam in particular is in a sweet spot to gain from this trend, given its mix of a cheap and educated labour force, a large and growing working-age population and an increasingly affluent middle class,” says Mr Narayanan.

StanChart argues that for South-east Asia to fully seize its chance, it needs to improve its infrastructure and do more to encourage foreign direct investment. Even then the path may not be straightforward, with the rise of the robots a threat looming on the horizon.

“Technology is (the region’s) greatest challenge to becoming the world’s manufacturing hub. Low-skill, repetitive jobs, which are more likely to move to Southeast Asia, are also prone to replacement by programmed machines and engineering advancements,” Mr Narayanan concludes.