Sino Hollow
Daniel Lian (Singapore)
The Three Scenarios of the Sino Hollow Thesis
The Sino Hollow thesis – that the rise of China’s competitive manufacturing sector will crowd out that of its key competitor, i.e., Southeast Asia – has been in existence for quite some time now. China’s rise has become a global economic phenomenon in the decade stretching over the last few years of the 20th century and the first few years of the 21st century. China last devalued in 1994, and global MNCs and capital started aggressively embracing the Middle Kingdom again from 1993-94. Following the Asian Crisis of 1997-98, China’s rise became even more assured as global MNCs, FDI and capital abandoned or reduced exposure to Southeast Asia in favor of China.
While the rise of China is not the subject of dispute, there seem to be three competing scenarios, each implying a different fate of Southeast Asia.
First is a complete hollowing out of manufacturing in Southeast Asia, with little proactive response in terms of reforms of the political economy or shifts in economic development strategy. Under this scenario, China’s inroads into global manufacturing are unstoppable, as its manufacturing industry stretches across the whole value-chain, leaving no breathing space for Southeast Asian manufacturers. China’s rise hits Southeast Asia the hardest as the latter was previously the preferred manufacturing outsourcing and production region for global MNCs. The decline of Southeast Asia is real and rapid as a total dismantling of its manufacturing industry cannot be offset by economic growth in other sectors. This is the worst-case scenario for Southeast Asia, whereby China prospers but Southeast Asia is poor.
Second is a massive manufacturing hollowing out met by some degree of reform of the political economy and some shift in economic development strategy. Under this scenario, the fundamental economic relationship between China and Southeast Asia evolves from one of manufacturing competition to a complementary service and resource demand/supply relationship. Southeast Asia’s ability to grow this complementary role, together with its pricing power on service and resource exports, determines its economic well-being. This scenario suggests an ambiguous outcome where China prospers and Southeast Asia’s economic well-being hinges on whether its policy responses bear enough economic fruit to offset the loss resulting from the massive destruction of its manufacturing potential.
Third is a partial hollowing out cushioned by a proactive and successful reform of the political economy and a shift in economic development strategy responses. Under this scenario, global MNCs diversify to avoid over-dependence on China and geopolitical considerations. Moreover, a probable rise in China’s wage bill and the operation of other supply constraints and wage-cost restraints in Southeast Asia contribute further to the incomplete hollowing out. In consequence, Southeast Asia loses some, but not the bulk, of its manufacturing potential. This, coupled with Southeast Asia’s new emphasis on alternative growth areas in services and resources, enables the region to supplement its economic livelihood and made good or better its losses in manufacturing. This is the best possible outcome for Southeast Asia, in my view, whereby China and Southeast Asia prosper together.
Pessimists and Complacent Asian Policy-Makers
There is plenty of evidence that Southeast Asia is now either responding or contemplating responses to the rise of China. Hence, I believe the investment community should assign little weight to the first scenario. Over the past four years, I have analyzed structural economic policy shifts and their progress in Singapore, Thailand and Malaysia. These policy shifts include Singapore’s new three-pronged growth strategy (Twin Trouble, but Different Destiny, August 4, 2004), Thailand’s well established dual track development strategy (Mr. Thaksin Has A Plan, September 21, 2004) and Malaysia’s move towards a more balanced economic platform (Policy Intent Is Key, November 14, 2003). There are also signs that both Indonesia and the Philippines are also contemplating changes. In my view, this constitutes firm evidence that the region is capable of responding to China’s challenge.
However, simply responding is one thing – succeeding in that response is another. Many members of the investment community remain structurally pessimistic about Southeast Asia. They believe that China is destined to become the world’s factory and that Southeast Asia’s decline will be severe and protracted.
I think I am a ‘constructive’ pessimist when it comes to the Sino hollowing arena (see Tycoon versus Labourer, June 7, 2001; Short-Term Breathing Space, November 6, 2001; and Crowded House, May 23, 2002). While I believe there will be proactive responses from Southeast Asia, I have serious doubts over the region’s ability to create high-value-added alternatives to manufacturing as it has chronically underinvested in services and resources. Thus, I subscribe to the more pessimistic aspects of the second scenario. In my view, becoming a low-value service provider and generic resource supplier to China and the world may not prevent a decline in living standards for Southeast Asians.
On the other hand, Asian policy-makers appear to me to be subscribing to the more optimistic part of the second scenario – i.e., successful development of a complementary relationship – as well as the most optimistic third scenario whereby China and Southeast Asia prosper together through shared manufacturing potential and a complementary service and resource demand/supply relationship. I disagree as I think that the Sino-Southeast Asia ‘complementary’ theory is far too complacent and that China will continue to ‘crowd out’ Southeast Asia’s growth potential.
Examining Hard Data a Decade After China’s Ascent
Examining hard economic data 10 years after the start of China’s rapid rise reveals some interesting economic trends.
1. Manufacturing remains very important to Southeast Asia. Most investors would have expected Southeast Asia’s manufacturing output and export shares to have shrunk following a decade of massive build-out in China. However, the ASEAN five actually raised their manufacturing output share as a proportion of GDP from 25% in 1994 to 30% in 2003. Concomitantly, their manufactured export share as a proportion of merchandise exports increased from 73% to 75% over the same period. While the intensity of manufacturing in ASEAN pales net to that in China (where manufacturing output as a proportion of GDP increased from below 40% to 45% and manufactured exports accounted for 88% of merchandise exports at the end of 2003), there is no evidence that China is forcing Southeast Asia to reduce its dependence on manufacturing.
2. China is indeed rapidly expanding its manufacturing potential. In terms of net FDI, the ASEAN five accumulated only US$147 billion (Singapore alone accounted for more than half, at US$82 billion) for the decade 1994-2003, whereas China picked up some US$392 billion. Furthermore, at the beginning of 1994 China’s combined manufacturing output was less than twice that of ASEAN; at the end of 2003, it was more than three times that of ASEAN (US$640 billion versus US$200 billion).
ASEAN’s manufactured exports have also registered far inferior growth compared with those of Greater China (China, Taiwan and Hong Kong). It makes sense to track Greater China as Taiwan and Hong Kong manufactured exports are linked to China’s manufacturing capacity. ASEAN’s manufactured exports grew from US$188 billion to US$326 billion from 1994 to 2003, whereas Greater China’s grew from US$344 billion to US$741 billion. Southeast Asia’s manufactured exports rose 73% over the 10-year period, versus 115% for Greater China.
3. ASEAN and China’s other two major competitors (South Korea and Mexico) have not lost their global share of manufactured exports. It seems that other countries/regions are bearing the brunt of China’s rise. The disaggregated shares of manufactured exports in global merchandise and manufactured exports show ASEAN manufacturing holding its ground despite the rise of China. ASEAN’s share of the global merchandise export shrank from 6.2% to 5.7% over the decade, a figure that is often cited by analysts – but we think this is comparing apples with oranges. In our view, a more accurate comparison is to track the manufactured export shares of global merchandise exports. Here the numbers reveal that ASEAN’s share remained constant, at 4.4%, whereas the shares of China and Greater China leapt from 2.2% to 5.3% and from 8.1% to 10.1%, respectively, implying gains of 3.1% and 2%.
We would make two observations here: first, while the rise in China manufacturing is real, as it has taken an additional 3.1% of the global merchandise export pie, it has taken share away from other manufacturing exporters, not from Southeast Asia. Second, the other usual assumed ‘victims’ of China’s rise – South Korea, Brazil and Mexico – have also avoided significant manufacturing declines. In fact, South Korea and Mexico saw their shares rise from 2.1% to 2.5% and from 1.2% to 1.9%, respectively (note, however, that stagnation in Mexico is evident, as its global share has dropped from a peak of 2.6% in recent years). Brazil lost only 0.1% of global share, declining from 0.8% to 0.7%.
4. Which other countries have lost manufacturing to China? Limited data preclude me from drawing a precise conclusion. However, since Southeast Asia, South Korea, Mexico and Brazil have not lost their global shares, it would seem that some other emerging and/or advanced economies must be the real ‘victims’ of Chinese ascendancy. Given what I see as the absence of other emerging economies with sufficiently sizeable manufactured exports to incur such a big loss of share, I conclude that advanced industrialized countries are the economies losing manufacturing share to China. This is a somewhat unconventional conclusion.
Southeast AsiaShould Avoid the Worst-Case Scenario
It is too early, based on the simple economic data and analysis above, to assert with confidence which of the three potential scenarios will materialize. My views are as follows.
1. There is indeed some ‘relative’ crowding out of Southeast Asian manufacturing by China/Greater China as the latter’s much faster growth rate has led to stagnancy in Southeast Asia’s global share. However, Southeast Asia continues to grow its exports and has not borne the brunt of the impact from China. Even if one uses merchandise exports as the barometer, the hit is minor, with Southeast Asia losing just 0.5% of global share. If the past decade marked China’s most aggressive incursion, then the economic data rule out the worst-case scenario and propel Southeast Asia towards the more favorable ‘partial hollowing out’ scenario.
2. The decade 1994-2003 saw global MNCs aggressively reconstructing their global production and supply chains away from Southeast Asia in favor of China. As a result, FDI flows over the past decade do not augur well for any improvement in, or even maintenance of, Southeast Asian manufacturing potential (the exception being Singapore, which continues to attract significant FDI). Hence, it is plausible that the next decade could well see continued aggressive hollowing. Still, if one assumes such hollowing out by Chinese producers in the coming decade, simple arithmetic suggests that Southeast Asia should not lose much of its manufacturing output and its global share in exports – its manufacturing base is quite large, and it would take a long time for the region to shed its US$200 billion worth of manufacturing output and 4.4% share of global merchandise exports (given that, despite aggressive inroads over the last decade, China has not taken share from Southeast Asia). This again pushes Southeast Asia away from the worst-case scenario and towards the more optimistic ‘partial hollowing’ scenario.
3. Southeast Asia needs political-economy reforms, as well as a shift in economic strategy, to avoid the worst-case scenario. There is ample evidence, albeit in varying stages of development and formulation, that Southeast Asia has embarked on changes to its political economy and economic strategy landscape. Singapore, Malaysia and Thailand thus far are the more proactive countries in this respect. Leaving aside political-economy reforms, just from an economic strategy perspective the efforts thus far include: diversifying and shifting manufacturing to higher-value-added activities (Singapore and Malaysia), creating and strengthening service exports (Singapore, Malaysia, Thailand) and developing sustained domestic demand through second track activities in agricultural, grassroots and SME sectors (Malaysia and Thailand). There are also clear signals from policy-makers in Indonesia and the Philippines that they are seriously contemplating both economic strategy changes and political economy reform. While it is too early to call all of these efforts ‘proactive’ and ‘successful’, the responses thus far certainly suggest to me that Southeast Asia is heading away from the worst-case scenario and towards either the second or third scenario.
Based on the above three points, I submit that Southeast Asia should avoid the worst-case scenario and that there is a chance it will also avoid the ambiguous second scenario.
Bottom Line: Southeast Asia Has Breathing Space
The Sino-Hollow thesis postulates China will make rapid and sustained inroads into global manufacturing and Southeast Asia will be its primary victim as the region used to be the dominant winner of global FDI by manufacturing MNCs.
While the rise of China is not the subject of dispute, there seem to be three competing scenarios, each implying a different fate of Southeast Asia. First is a complete hollowing out of manufacturing with no proactive policy response from Southeast Asia. This is the worst-case scenario for Southeast Asia. Second is a massive manufacturing hollowing out met by some degree of reform of the political economy and a shift in economic development strategy responses from Southeast Asia. This is an ambiguous scenario as the new economic initiatives and better political economy may not offset the loss incurred in manufacturing potential. Third is a partial hollowing out of manufacturing with proactive and successful reform of the political economy and a shift in economic development strategy, whereby Southeast Asia could well retain or even improve its standard of living. This appears the best-case scenario for the region.
Data over the past decade indicate that Southeast Asia’s global share of manufactured exports remains stagnant, at 4.4%, whereas that of China and Greater China has risen from 2.2% to 5.3% and from 8.1 to 10.1%, respectively. Other assumed ‘traditional victims’ of China’s rise – i.e., the manufacturing sectors of South Korea, Mexico and Brazil – were also not hollowed out by China. I think China may, in fact, have gained global manufacturing shares from advanced industrialized countries, as there are no other large manufacturing-intensive emerging economies to be hollowed out.
It is too early to arrive at the right scenario. However, based on the hard evidence of the past decade, policy responses (both political economy reforms and economic strategy shifts) by Southeast Asia, and economic projections based on simple arithmetic, I submit that Southeast Asia should avoid the worst-case scenario. I also see a chance that it can also avoid the ambiguous second scenario and head for the best-case scenario.
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