Shifting Supply Chains: Foreign Direct Investment Likely to Expand in Southeast and South Asia in Response to Trade War

16 October 2018

As the trade war between the United States and China has escalated, businesses operating in both countries are experiencing parallel pressure to rethink and adjust supply chains to remain competitive. Currently, Chinese imports to the USA worth $250 billion are facing levies that will extend to 25% by early 2019, while $110 billion of American goods are already facing duties between 5 to 10% in China. The implications of these trade tensions for Asia and the Pacific are analyzed in detail in ESCAP’s forthcoming Asia-Pacific Trade and Investment report, which will be released this December. One likely consequence we analyze is that it will spill over beyond exports and imports, and spark investment diversions from China and the USA to Southeast and South Asia as businesses attempt to mitigate tariffs on both sides of the Pacific. Such shifts in foreign direct investment (FDI) can be leveraged in both subregions to further stimulate inclusive and sustainable growth.

Enterprises beyond America and China have already reported significant headwinds from the tariffs. Some auto firms, including BMW and Tesla, plan to transfer the costs of the tariffs to consumers by raising the prices of their vehicles imported from the USA and sold in China. Other firms are developing contingency plans to relocate or reshore some or all production, which would significantly alter the direction of FDI flows in the coming years.

Production shifts may become an increasingly compelling business strategy to maintain competitive advantage as uncertainty grows amidst trade tensions. Anecdotal evidence collected by ESCAP confirms at least 31 manufacturing firms are seriously considering relocating or reshoring to trim exposure. Recent surveys of American and European businesses in China further illustrate the tariff war’s looming effects on future investments. Of 430 American firms surveyed, 61% reported that they would readjust their supply chains to source and/or assemble either outside of China or the USA, and 27% disclosed they were considering relocating outside of China or the USA. By comparison, of the 193 European firms surveyed, nearly 12% are considering moving production out of China and 5% are no longer sourcing inputs from the country. Large firms such as Harley Davidson and Kaymatics have already confirmed relocation to Southeast Asia. While Foxconn, an equipment manufacturer for Apple, Amazon, Microsoft and other brand name electronic companies, announced plans to reshore production to the USA.

While most firms are hesitant to act prematurely, they have nonetheless initiated a steady wave of official business-scouting missions to Malaysia, Myanmar, Thailand and Viet Nam. Of the American firms surveyed, 18.5% are exploring moving production to ASEAN, while 6.3% are considering South Asia. Both subregions are attractive destinations because of their low production costs and ability to accommodate large-scale shifts of production. Within ASEAN, Malaysia and Viet Nam have a competitive advantage compared to other countries in the subregion as both are party to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership.

Relocation and reshoring are, however, not easy and require time – time to get the right staff, the right permits, the right location, and the right logistic and distribution networks in place. Moreover, China is not easily replaceable, boasting some of the best infrastructure, supply chain networks and engineering talent in Asia and the Pacific. As firms recalculate their Chinese supply chains, they are evaluating potential costs and benefits. For China, reshoring and relocation moves could hasten the upgrading of Chinese companies into middle- and high-range products.

A time lag between the relocation and reshoring moves of firms and their appearance in official FDI figures is of course to be expected. Moreover, the full effects on FDI from the trade war also depend on whether the USA imposes any additional tariffs and if so how China responds. In addition to increased tariffs from either side, there is a real possibility that the USA could extend tariffs to Southeast and South Asia. Tariff expansion could subsequently deter supply chain adjustments and related investment redirections to these subregions.

The dynamics of investment flows in Asia and the Pacific are changing, and the trade war provides new opportunities for countries in Southeast and South Asia to attract FDI, particularly in the manufacturing sector. Such investment flows could, in turn, also provide increased opportunities for small- and medium sized enterprises in these economies to integrate themselves into global value chains. However, in capitalizing on these opportunities, it is essential that host countries ensure that investments deliver sustainable benefits. Doing so critically depends on the ability of governments in the region to assess and evaluate the sustainability characteristics of FDI and to implement the appropriate investment policy and regulatory frameworks.

To this end, ESCAP is developing country-specific FDI sustainability indicators and has already developed a Handbook on FDI Policies to support member States in promoting and attracting sustainable FDI. It is hoped that policymakers in the region will utilize these resources to harness investment flows which generate the maximum sustainable development benefits for our region.

***To learn more about the trade war and other issues related to its impact on Asia and the Pacific, check back with ESCAP in December to download the Asia and Pacific Trade and Investment Report 2018.