China

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

Source : FT 29 July 2016 - Steve Johnson

 

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.

 

South Korea under pressure as China competes head on

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 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.

 

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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.

Vietnam set to be the biggest winner from the Middle Kingdom’s move up the value chain

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 $100 and $200, a fraction of the $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.

 

Dingdong

 

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.

Southeast 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 Chidu Narayanan, Asia economist at StanChart.

 

As well as the obvious benefits of a cheaper labour force, Mr Narayanan argues that Southeast Asia’s strong economic growth and “rising middle class” offers 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.

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StanChart argues that for Southeast 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.

 

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Having attained middle-income status, Vietnam aims higher

 

Source: The Economist Aug 6th 2016

 

WHEN Jonathan Moreno’s company was looking for a location for a new factory in 2009 to make its medical devices, it ruled out much of the world. Europe and the Americas were too expensive, India was too complex and intellectual-property rights in China too patchy. In the end, Vietnam was the one candidate left standing. It still seemed risky as the country was just emerging as a destination for foreign investors. Seven years on, Mr Moreno surveys the scene—employees assemble delicate diagnostic probes in a room that resembles a laboratory—and has no doubt about where his company, Diversatek, will expand next. “To the back, there and there,” he says, pointing to either side.

It is far from alone. Foreign direct investment in Vietnam hit a record in 2015 and has surged again this year. Deals reached $11.3 billion in the first half of 2016, up by 105% from the same period last year, despite a sluggish global economy. Big free-trade agreements explain some of the appeal. But something deeper is happening. Like South Korea, Taiwan and China before it, Vietnam is piecing together the right mix of ingredients for rapid, sustained growth.

Vietnam already has a strong, often underappreciated, record. Since 1990 its growth has averaged nearly 6% a year per person, second only to China. That has lifted it from among the world’s poorest countries to middle-income status. If Vietnam can deliver 7% growth for another decade, its trajectory would be similar to those of China and the Asian tigers (see chart). But that is no sure thing. Should growth fall back to 4%, it would end up in the same underwhelming orbit as Thailand and Brazil.

 

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Perhaps the biggest factor in Vietnam’s favour is geography. Its border with China, a military flashpoint in the past, is now a competitive advantage. No other country is closer to the manufacturing heartland of southern China, with connections by land and sea. As Chinese wages rise, that makes Vietnam the obvious substitute for firms moving to lower-cost production hubs, especially if they want to maintain links back to China’s well-stocked supply chains.

A relatively young population adds to Vietnam’s appeal. Whereas China’s median age is 36, Vietnam’s is 30.7. Soon enough, it will start ageing more rapidly but its urban workforce has much scope to grow. Seven in ten Vietnamese live in the countryside, about the same as in India—and compared with only 44% in China. The reservoir of rural workers should help dampen wage pressures, giving Vietnam time to build labour-intensive industries, a necessity for a nation of nearly 100m people.

Many other countries also boast young workforces. But few have had as effective policies as Vietnam. Since the early 1990s the government has been very open to international trade and investment. This has given foreign companies the confidence to build factories. Foreign investors are responsible for a quarter of annual capital spending. Trade accounts for roughly 150% of national output, more than any other country at its level of per-person GDP.

Investors have also taken heart from the stability of Vietnam’s long-term planning. Like China, it has used five-year plans as rough blueprints for development. But also like China, its governance allows scope for innovation: its 63 provinces compete with each other to attract investors. A model of developing industrial parks with foreign money and managers began in Ho Chi Minh City in 1991 and has since been replicated elsewhere.

And Vietnam’s workforce is not just young but skilled. Public spending on education is about 6.3% of GDP, two percentage points more than the average for low- and middle-income countries. Although some governments spend even more, Vietnam’s expenditures have been well focused, aiming to boost enrolment levels and ensure minimum standards. In global rankings, 15-year-olds in Vietnam beat those in America and Britain in maths and science. That pays dividends in its factories. At Saitex, a high-end denim manufacturer, workers must handle complex machinery—from lasers to nanobubble washers—all to produce the worn jeans so popular in the West.

On top of this solid foundation, Vietnam is reaping benefits from trade deals. It is set to be the biggest beneficiary of the Trans-Pacific Partnership (TPP), a 12-country deal that includes America and Japan. With American politics turning hostile to trade, there is a risk that the TPP will fail. But even if that happens, Vietnam will do well. The TPP has already helped to advertise its capabilities. And there are other major agreements: a free-trade pact with the EU is in the works, and one with South Korea went into force in December.

Yet Vietnam also faces a series of challenges, any of which could impede its rise. Speculative excesses in the past helped fuel a property bubble. It burst in 2011, saddling banks with bad debts. Vietnam created a “bad bank” to house the failed loans and has started cleaning up its banks. However, it has been slow to inject new capital into its banks and hesitant about modernising their operations.

In one crucial area it compares poorly with China: getting the most out of the private sector. Private Chinese companies generate about 1.7 yuan of revenue per yuan of assets, more than double the 0.7 ratio for state-owned enterprises (SOEs). In Vietnam private-sector productivity has slumped over the past decade to the 0.7 level, the same as SOEs, says the World Bank. One reason is that large groups in Vietnam sprawl across 6.4 separate industries on average; those in China operate in just 2.3, according to the OECD.

Furthermore, although Vietnam has benefited from foreign investment, only 36% of its firms are integrated into export industries, compared with nearly 60% in Malaysia and Thailand, according to the Asian Development Bank (ADB). In some cases Vietnam has gone too high-end. Much has been made of Samsung’s plans to invest $3 billion in mobile-phone production in Vietnam, but domestic suppliers provide it with little except plastic wrapping. Vu Thanh Tu Anh, director of the Fulbright Economics Teaching Program in Ho Chi Minh City, says the government needs to help build up supply chains—for example, training companies in textile production to support the apparel sector.

There are grounds for cautious optimism. The Ministry of Planning and Investment teamed up with the World Bank to lay out a strategy for change earlier this year. Their joint report, “Vietnam 2035”, details how the country can make SOEs more commercial and reinvigorate the private sector. Weakened public finances—the fiscal deficit is set to be more than 6% of GDP for the fifth straight year in 2016—are putting pressure on the government. To bolster its revenues, it sold shares in more than 200 SOEs last year, the biggest annual tally ever. These were mostly small deals but in July it took a bolder step, scrapping a foreign-ownership limit (previously 49%) on Vinamilk, the country’s main dairy company. Investors are hopeful this will serve as a template for more such reforms.

After years of solid growth, Vietnam has nearly reached a milestone. Now it is classified as a middle-income country, it is about to lose access to preferential financing from development banks. In 2017 the World Bank will start to phase out concessional lending. For Vietnam it is a moment to reflect on how far it has come and also on the trickier path ahead. It has a chance to be Asia’s next great success story. It will take courage to get there.

 

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