ASEAN set to become Asia’s next Pearl River Delta

Kelvin Lau Senior Economist, Greater China and North Asia

26 May 2015

Manufacturers look to relocate from China to ASEAN as wages continue to rise

ASEAN is poised to become Asia’s next low-cost manufacturing powerhouse as wages in China’s Pearl River Delta (PRD) factory belt continue to creep up. As China sees waning wage competitiveness, ASEAN stands to gain, with its lower costs and abundant supply of labour over the next 20 years.

ASEAN’s high rate of GDP growth, and rising household affluence, means companies relocating from the PRD could capture a share of a large and growing consumer market.

Our latest survey shows that manufacturers in the PRD – spanning nine cities in China’s Guangdong Province and accounting for 27 per cent of Chinese exports – continue to face persistent labour shortages and rising wages.

Rising wages reflect China’s improving productivity and the increasing complexity of the products it makes

Kelvin Lau, Senior Economist, Hong Kong

At the macro level, this is good news for China, as maintaining a stable labour market and healthy income growth are priorities for Beijing. Rising wages reflect the country’s improving productivity and the increasing complexity of the products it makes. It confirms China’s transition to high-end manufacturing and a more sustainable growth model.

At the company level, however, labour shortages mean more cost for PRD manufacturers.

We spoke to 290 Hong Kong and Taiwan-based manufacturers operating in the PRD, and more that 85 per cent said labour shortages are at least as bad as last year. Migrant worker wages are expected to rise 8.4 per cent on average this year, against 8.1 per cent in 2014, pointing to an overall real wage growth of 6.8 per cent.

Manufacturers relocate overseas

Wages account for over one-fifth of the PRD manufacturers’ total cost base on average, so another year of strong wage growth could materially impact their bottom line. The companies we spoke to also expressed continuing concerns about narrowing margins, tight credit conditions, the still-cautious outlook for orders, and an increasingly volatile Chinese yuan.

Despite these short-term challenges, there are opportunities in China for those willing to adapt. Investing in automation and streamlining processes is the most common response to labour shortages and rising wages among the PRD manufacturers in our survey. This lends weight to the International Federation of Robotics’ estimate that China is set to overtake the EU and North America by 2017 as the world’s biggest user of industrial robots.

But more than 30 per cent of the companies we spoke to are planning to respond by relocating their factories – some further inland in China, and some overseas, with Vietnam and Cambodia the preferred location.

Vietnam is poised to be one of the biggest beneficiaries, as low-costs manufacturing shifts away from the Pearl River Delta

Kelvin Lau, Senior Economist, Hong Kong

As China’s manufacturing sector transforms, ASEAN’s is likely to grow. While wages may still be competitive in some parts of China, particularly the West, the shrinking labour force means that wages are likely to catch up quickly with those in Eastern China.

Vietnam, with its geographical proximity to China, is poised to be one of the biggest beneficiaries, as low-costs manufacturing shifts away from the PRD. The companies in our survey estimate that moving here could give them an average cost reduction of 19 per cent. Cambodia, on the other hand, could yield a 20 per cent saving on wages.

As a whole, ASEAN has strong and varied manufacturing capabilities – from low-cost factories in Cambodia, Laos, Myanmar, Vietnam and Indonesia, to mixed manufacturing and electronics in Thailand, Malaysia and the Philippines, and high value-added production in Singapore.

Take note of China’s experience

To make the most of these diverse strengths, however, ASEAN needs to achieve better integration. In addition to improved infrastructure links, a common regional framework for investment regulation would make it much easier for companies to adopt a pan-ASEAN strategy with operations located across the region.

Many factors have contributed to China’s extraordinary performance as a global exporter, but its strong openness to trade and investment – including the establishment of Special Economic Zones with lower taxes, limited trade barriers and a supportive bureaucracy – has been key, in my view.

ASEAN may well take note of China’s experience, which demonstrates the importance of external trade in improving economic structure and propelling growth. The potential prize is huge. As foreign direct investment continues to shift from China to ASEAN, the region may close its gap with China and become one of the world’s largest exporters.

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