Why ASEAN Overtook China’s Foreign Investment Last Year
Demographics & Free Trade Are Re-Shaping the Supply Chain Further Into Asia
Op-Ed Commentary: Chris Devonshire-Ellis
The ASEAN 5 – the large trading countries of Singapore, Malaysia, Indonesia, the Philippines and Thailand – last year achieved Foreign Direct Investment inflows of some US$128.4 billion, overtaking that of China at US$117.6 billion, according to figures released by Bank of America Merrill Lynch (BAML) last week. That US$128.4 billion represented a 7 percent year-on-year increase in FDI for these ASEAN countries last year, while China faced a 3 percent dip to US$117.6 billion. The BAML figures were calculated using official data and an estimate for Philippines FDI in Q4.
This trend demonstrates a number of issues coming into play. Often touted as being caused by an increase in China labour and operational costs, the decline of FDI in China is only partially to do with increased costs. A major driver for the re-positioning of FDI into Asia is rather two other major forces converging – regional demographic change, and the ASEAN-China Free Trade Agreement.
In terms of the demographic changes, China is getting older. As a result, it has reached over the hump of what is known as the age-dependency optimum and is now losing workers – and fast. 2013 saw 2.4 million workers retire from China’s labour force, these not being replaced, while the number of elderly Chinese is expected to reach 30 percent of the population by 2030. The Chinese government is well aware of these trends and has been reacting accordingly – and with little financial means to fund a welfare state, they have been deliberately creating an increasing wealthy society – the annual 10-20 percent increase of minimum wages being part of this.
This is now creating a middle class consumer base of some 600 million by 2020 – and will steadily increase to that number over the next six years from the 250 million now extant today. That’s an average of 58 million new Chinese middle class consumers being created each year from now for the next six years – a figure equivalent in size of the entire population of Great Britain.
This aging of China is now having two effects – an increasingly expensive workforce, and a rising middle consumer class. It is the latter reason that FDI into China continues to be strong – finally, the Chinese market is maturing and those aggravating trade gaps may now start to come down as increasing numbers of companies export to fulfill China’s needs. China is a country that increasingly offers opportunities to sell to, and existing China players are remaining based in the country to oversee this. China’s middle class consumer base of 250 million now is the basis from which such investors have made their China strategy.
But the difference between serving a consumer base of 250 million today and 600 million in seven years is rather different – and the FDI required to service this discrepancy of 350 million consumers is now going to Asia. That is what is reflected in the BAML data.
The reasons for the rise of Asia is that same age-dependency ratio sweet spot, where the maximum number of workers have to support the minimal amount of elderly. With an age dependency ratio of just 10 people aged 65 or above in every 100, Asia is beginning to inherit the worker dividend that China – where the age dependency ratio is now 36 and climbing – is now giving up. That shift covers two neighbouring regions in particular, ASEAN and India.
In terms of the ASEAN shift, that is further enhanced by the China-ASEAN Free Trade Agreement, which kicked in just over three years ago. It has reduced tariffs to practically zero on 90 percent of all goods traded between ASEAN nations and China. That means that as countries such as those mentioned in the BAML report – and specifically manufacturing destinations such as Indonesia, Malaysia, Philippines and Thailand now provide cheaper labour and production options. These, together with rapidly improving infrastructure, means manufacturing no longer needs to be physically based in China to service the China consumer market. It can be based in these lower cost destinations instead, and that again is what the BAML data shows us.
But what about Vietnam? Vietnam, although a member of ASEAN has not yet fully reached compliance with all its ASEAN free trade obligations – but is expected to do so by the end of next year. Vietnam has also stated it will reduce corporate income tax to 20 percent by 2016 – a full 5 points lower than China. When it does, and when it comes into AEC compliance, it can be expected that a boom in FDI into Vietnam will take place, with that production being financed also mainly being directed at the increasingly large Chinese consumer market.
India also comes into the picture, although BAML didn’t specifically mention it in the report. It too is moving into that same demographic sweet spot as the ASEAN nations, and provides an even larger available workforce. There are a number of issues that are still in the process of being sorted out in India, not least its relatively high tax rate – tax reform is on the agenda – an awkward political system, and infrastructure problems. The country is also due to hold elections this year; meaning not much will occur in the realm of reforms until the makeup of the new Government is known.
But again, it is hard to get away from those demographics. While China lost 2.4 million workers in 2013, India gained 7 million, and with an average wage for an Indian worker in Mumbai of US$250 compared with US$760 (plus another 50 percent social welfare) in Guangzhou, a Chinese worker is effectively five times more expensive than an Indian one, and that gap will widen further. In terms of India’s infrastructure, it has been improving massively, as anyone who has flown into the new Delhi or Mumbai airport terminals will be aware. Yet much remains to be done. China meanwhile is so desperate to ensure an adequate supply of cheap goods for its middle class and increasingly elderly society that it has made an astonishing offer to India to fund 30 percent of the estimated US$1 trillion infrastructure needs the country has. Put simply – China needs cheap Indian manufactured goods to keep its own aging population happy, and is prepared to incentivise India to supply that demand.
Of additional note to ASEAN investors is that India, which also has a middle class consumer base of 250 million, additionally has a Free Trade Agreement with ASEAN. Similar to the ASEAN agreement with China, the deal cuts tariffs on 90 percent of all products traded between ASEAN and India to essentially zero. The two trade partners have also gone one step further than China’s agreement, by agreeing to slash tariffs on services and investment, which is a big boom for the ASEAN de facto capital of Singapore.
These dynamics then will ensure that for the foreseeable future, FDI into ASEAN will increase significantly over that going into China. Manufacturing capacity to service a new market of 350 million more Chinese consumers by 2020 will head to ASEAN, while ASEAN also makes sense as an investment destination for those same global manufacturers to begin reaching out to the Indian market. The trend has already started. Foxconn are relocating their China operations to Indonesia, while Ford recently placed their non-U.S. automotive manufacturing capacity into Gujarat.
Manufacturing businesses currently based in China are studying where to place future growth capacity for the Chinese domestic market – and which ASEAN nations in particular offer the appropriate solutions in terms of cost and production efficiencies.
Chris Devonshire-Ellis is the Founding Partner of Dezan Shira & Associates – a specialist foreign direct investment practice providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam, in addition to alliances in Indonesia, Malaysia, Philippines and Thailand, as well as liaison offices in Italy and the United States.
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