Asia House Advisory analysis shows that Vietnam and Malaysia can benefit from the US-China trade disruption – but each have their own challenges to overcome.
In a recent CNBC interview, Malaysia’s Minister for International Trade and Industry, Darell Leiking – who visited Asia House on 27 January – said Malaysia is benefiting from the US-China trade war, despite not looking to take advantage of the tensions.
His comments echoed those of Muhammed Abdul Khalid, an economic advisor to Prime Minister Mahathir Mohamad, who said last month that the trade war is forecast to add 0.1 percentage points to Malaysia’s gross domestic product (GDP). The forecast is based on Malaysia foreseeing an increase in China-based manufacturers shifting operations to the Southeast Asian country to avoid additional US tariffs.
Khalid’s remarks offered further anecdotal evidence that Malaysia stands to benefit from accelerated trade diversions due to the US-China tensions.
Darell Leiking, Minister for International Trade and Industry, Malaysia, briefed Asia House Corporate Members in January 2020.
The notion that some Southeast Asian markets could see gains from the trade war is well established. So far, Vietnam has been cited by many analysts as the main beneficiary. Indeed, in the past two years, Vietnam has enjoyed a ‘winning streak’, attracting an increasing number of manufacturers moving production away from China.
Companies are now increasingly looking to relocate from China and diversify their supply chains while still maintaining easy access to China’s huge customer market. As trade policy uncertainty continues and more general global and regional trends contribute to supply chain shifts, more Southeast Asian countries are likely to reap the benefits of companies moving operations from China.
It is unlikely that any country stands to benefit from the trade war in the long run. However, in the short term, in addition to Vietnam, Malaysia is well placed to benefit from trade diversion. It stands to absorb an ever-larger share of production capacity, particularly in the electrical and electronics (E&E) sector.
The main question for Vietnam and Malaysia, though, is how to ensure these short-term gains of trade diversion lead to long-term benefits.
What’s driving the shift?
The current tensions between Beijing and Washington are not the only forces at work. A decade ago, China was among the most popular places for companies to manufacture their products. This trend has begun to reverse in recent years, mainly due to rising Chinese labour costs and tougher regulations. Labour intensive value chains – particularly garment and footwear production – have been moving away from China to countries such as Vietnam and Cambodia, where labour costs are typically lower.
This supply chain shift has been accelerated by the US-China trade war. Over the past 18-months, China-based manufacturers have been hit hard by high tariffs on US imports worth over US$360 billion. Higher tariffs and prolonged trade policy uncertainty have damaged investor confidence and disrupted the China-centric manufacturing supply chains and trade flows. This has forced many multinational companies to reassess their China-strategy and look for alternatives.
‘Nearly 50 per cent of the companies said
they will shift supply chains, and
25 per cent said they were looking to invest
more in local supply chains.’
According to the 2018 McKinsey Global Executive Survey, trade policy uncertainty and the recent tariff increases were main concerns for 33 per cent and 25 per cent of the companies surveyed respectively. Nearly 50 per cent of the companies said they will shift supply chains in response, and 25 per cent said they were looking to invest more in local supply chains.
Although the ‘Phase One’ trade agreement signed by the US and China on 15 January signals a de-escalation of the immediate economic conflict, and goes some way towards increasing investor confidence, it leaves in place tariffs on US$250 billion of Chinese imports. The agreed tariff reductions will also not take place until there is ‘Phase Two’ deal, which is anything but certain. This means companies and consumers are set to continue to pay more than they did before the trade war took hold.
Ultimately, the ‘Phase One’ deal does not resolve the underlying US-China geopolitical rivalry and strategic competition over economic creativity and new technologies. As such, the potential for renewed conflict between the two remains high. This increases overall business risk for companies operating in China and makes a strong case for supply chain diversification to mitigate any future risks.
Countries in focus
For companies looking to relocate, Vietnam’s fast-growing manufacturing base offers an attractive alternative to China. Vietnam’s political stability, lower labour costs, similar export basket to China, pro-investment policies and tax incentives make the country an attractive prospect. In addition to proximity to China’s huge customer market, Vietnam is benefiting from its own growing consumer base and spending power.
As Vietnam climbs up the value ladder, the share of labour-intensive manufacturing exports, such as garments and footwear, is falling. Vietnam still attracts big footwear companies, such as Nike and Adidas, to its southern manufacturing hubs. However, the electrical machinery and equipment sector has been the fastest-growing export sector since 2017, and accounts for roughly 40 per cent of total exports. To attract higher value foreign direct investment (FDI) and to directly compete with South China, the government is encouraging research and development in software and its high-tech hardware sector.
This longer-term strategy has proven successful. In 2019, several big high-tech hardware companies, including Samsung, shifted production to Vietnam from China. Since 2000, Vietnam has maintained GDP growth rate of more than six per cent. In 2019, Vietnam’s economy grew by a record 7.02 per cent, according to government data. This was higher than the target set by the National Assembly. The government cited strength in manufacturing and exports as the main reason for the record result. This was against the backdrop of global economic slowdown due to the trade war.
The outlook for continued investor interest is positive. Vietnam’s new generation free trade agreement (FTA) with 28 European Union member states, signed in June 2019, also paves the way for increased trade.
Keeping up with demand
The key challenge for Vietnam is meeting the demand across both infrastructure and workforce capacity. While Vietnam has a large pool of relatively well-educated and young labourers, only 12 per cent of Vietnam’s 57.5 million-strong workforce are highly skilled, according to recruitment firm ManpowerGroup. A shortage of highly skilled workers, including IT workers, engineers and managers – particularly in the south – is likely to put limits to rising demand.
Furthermore, whereas Vietnam currently invests heavily in infrastructure – nearly double the global average – it is struggling to keep up with its economic growth and increasing demand for energy, transport and telecommunications. These will need to be addressed if Vietnam’s long-term gains from the trade war disruption are to be realised.
In addition to Vietnam, Malaysia has been identified as an alternative production base within the Association of Southeast Asian Nations (ASEAN), particularly for the electrical and electronics sector. Like Vietnam, its strengths include low operating costs and a strategic location within the East-West trade route. Where Malaysia excels over Vietnam is infrastructure. In contrast to Vietnam, Malaysia already offers one of the most well-developed transport, electricity and high-tech communication services in Southeast Asia. Specialised industrial parks also cater to the needs of specific industries.
For E&E manufacturers, the coastal state of Penang offers two industrial zones with good infrastructure and a long-established ecosystem of suppliers and customers. The benefits of this has been recognised by E&E companies looking to relocate from China. According to government data, FDI into Penang rose 11-fold to approximately US$2 billion in the first half of 2019 compared to any other full year. It is well embedded in the regional and global supply chains and offers a globally competitive base and quick transfer for companies’ complete production lines.
While domestic political uncertainty following the 2019 elections tempered investment and slowed the economy, the US-China trade war has given Malaysia a much-needed boost in the short term. For long-term growth, the government promotes high value-added activities in the E&E sector through tax incentives. It is looking to move up the electronics value chain and produce more innovation-driven products, such as semiconductors.
While Malaysia boasts a large English-speaking workforce, it needs more highly skilled workers to attract more innovation-driven activities, according to the World Bank Development 2020 report. Brain drain, the flow of highly-skilled nationals out of the country, remains a key problem for Malaysia that is aiming to become a high-income nation by 2024.
Although the outlook is positive, a talent shortage could slow down Malaysia’s progress. According to Hays recruitment company’s 2019 report, 46 per cent of employers throughout Malaysia are feeling less confident in finding and securing higher-skilled talent needed to drive business growth.
Future outlook for Vietnam and Malaysia
Looking ahead, both Vietnam and Malaysia are likely to further benefit from their trade openness as supply chains shift. Regional free trade agreements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP) promise increased trade opportunities to both Vietnam and Malaysia. The CPTPP, which covers Canada and 10 other countries in the Asia-Pacific region, including Vietnam and Malaysia, came into effect in January 2019. The RCEP agreement is expected to be signed in 2020. Signatories to the RCEP collectively represent nearly 50 per cent of the world’s population and account for approximately 28 per cent of global trade, for which the agreement is set to eliminate tariffs on 65 per cent of trade in goods. This is likely to benefit Malaysia and Vietnam’s exports to China and South Korea.
However, more can be done to boost growth and increase investment in the domestic policy front to take full advantage of the opportunities ahead. For Vietnam, addressing infrastructure gaps and boosting labour’s skill level is a must if it is to move up the value ladder and take advantage of growing manufacturing demand. For Malaysia, boosting workers’ skill levels to meet the needs of more innovation-driven products will be crucial in order to benefit from trade diversion in long-term.
This analysis was produced by Asia House Advisory, which helps organisations meet business-critical challenges through a range of bespoke services. To find out more about Asia House Advisory and how it can help you, please email firstname.lastname@example.org