The Potential of ASEAN Revisited

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2 The Potential of ASEAN Revisited KIM Kyung-Hoon OPPORTUNITIES IN ASEAN The economies of the Association of Southeast Asian Nations (ASEAN) have shown remarkable resilience to the effects of the 28 global financial crisis. After recovering from the earlier 1997 Asian currency crisis, ASEAN built up foreign currency reserves and signed currency swap deals with other nations, strengthening its readiness for future crises. This allowed ASEAN to rapidly return to stable growth after the most recent financial crisis, even as ad- Figure 1 Attractiveness of ASEAN Economies (US$) Production Base After China Wage Levels China Thailand Philippines Indonesia '97 ' '3 '6 '9 '12 '15 By 215, 2-6% of wage in China (1 million) Consumption Market Middle Class Population ASEAN India Brazil Russia By 22, 1 million middle class population (1 million) 26 Infrastructure Market Urban Population By 22, 33 million urban population Natural Resources Rise of Late-comer ASEAN Countries Production Share 211 Annual Average GDP Growth (%) (%) Palm Oil (21) Rice (21) Nickel Tin Natural Gas Coal Cambodia (C) Laos (L) Myanmar (M) Vietnam (V) Source: EIU; Euromonitor; UN, WUP; BP, SRWE; USGS (212). Mineral Commodity Summaries; FAOSTAT; IMF, WEO. April 213 SERI Quarterly 61

3 The Potential of ASEAN Revisited Figure 2 Korea s Exports to Major Economies (Share) Figure 3 Korea s Outbound FDI to ASEAN and China (%) (%) China ASEAN US EU Japan ASEAN China ~26 27~29 21~Sep. 212 Source: Korea International Trade Association. Source: Korea Exim Bank. vanced countries struggle to gain their footing. Seeking to move beyond the BRICs (Brazil, Russia, India and China) economies, many leading firms have been increasing their investments in ASEAN. Such investments are driven by four factors: 1) ASEAN s potential as a production base after China; 2) rapid expansion of consumption and infrastructure; 3) ample natural resources; and 4) reform and opening by ASEAN s less developed members. In 211, foreign direct investment (FDI) in ASEAN rose 25.7 percent to reach a record-high of $116.5 billion. ASEAN s importance to Korea s export-driven economy waned after the 1997 Asian currency crisis, when trade with China soared. After the most recent crisis however, Korean exporters have increasingly returned to ASEAN to compensate for weak demand in the US and Europe, which in turn has stifled demand in China. Share for Korean exports to ASEAN increased from 11 percent in 21, to 13 percent in 211 to 14 percent in 212, making ASEAN Seeking to move beyond the BRICs (Brazil, Russia, India and China) economies, many leading firms have been increasing their investments in ASEAN. 62

4 KIM Kyung-Hoon Korea s second-largest export market. Korea s outbound FDI to ASEAN countries exceeded its investments in China in 21. In 212, the Korean government established a diplomatic mission in ASEAN to strengthen relations with the region. FIVE KEY QUESTIONS ON THE ASEAN ECONOMY ASEAN s economic and population growth rates will make it an increasingly vital destination for Korean firms. The International Monetary Fund forecasts that ASEAN s GDP will increase to $3.8 trillion by 217, while its population will grow to 66 million. This will mean a per capita GDP of $5,782, a significant rise. Competition in ASEAN will intensify as mature members like Singapore and Thailand try to entrench their position while newer and poorer members try to catch up. This paper discusses five questions regarding ASEAN as an investment destination. Will ASEAN Become the World s Workshop? In labor-intensive industries, ASEAN s competitiveness has already surpassed that of China by offering an ample supply of young, low-cost workers. The working-age population will grow rapidly until 225, and ASEAN s demographic bonus i.e. its comparatively large working age population and its comparatively small dependent population will continue to pay dividends for the next 3 years. In contrast, China is losing its status as the world s No. 1 workshop. Rising wages and the appreciation of the yuan are pushing up production costs. China s wages versus those of Indonesia increased from a ratio of two to one in 25 to three to one in 212, with the Economist Intelligence Unit projecting this number to rise to 4.5 to one by 215. Several manufacturers have already shifted operations from China to ASEAN. Japan s clothing and textile makers have already started transferring production bases to newcomer countries like Vietnam. This replicates past pat- Figure 4 ASEAN on the Move GDP Population Per Capita GDP ($1 trillion) (1 million people) (US$) $1.5 trillion Increase 3.8 Increase of 47 million people 6.6 $2, Increase 5, , Compared to the eurozone economies 19% 29% Increase equivalent to Korea's entire population Increase to the level of China Source: IMF, WEO. April 213 SERI Quarterly 63

5 The Potential of ASEAN Revisited terns where Japanese firms relocated to Korea and Taiwan in the 197s, then to ASEAN economies like Thailand in the mid-198s, and finally to China in the 199s. In capital-intensive industries, including electronics and automobiles, leading global companies are building production bases in ASEAN for risk diversification and market entry. Major Japanese carmakers including, Toyota, Nissan, Honda and Mitsubishi are strengthening the China+1 strategy by building factories in Thailand and/or Indonesia to secure production capacity. To accommodate manufacturers and other types of companies, the more open ASEAN economies are continuously promoting their business-friendly environment. According to the World Bank s Ease of Doing Business index, Singapore (No. 1)and Thailand (No. 18) rank on par with advanced countries, while Vietnam (No. 99) and Indonesia (No. 128) are at the level of the BRICs countries. ASEAN countries are also providing various incentives to foreign companies to facilitate job creation and establish industries. However, ASEAN members need to improve their infrastructure and stabilize their labor market if they hope to replace China as the world s center for final assembly. Roads and reliable energy supplies in low cost ASEAN countries are still not at China s level, while conditions for parts and raw materials procurement remain weak. Survey results released by the Korea Trade Investment Promotion Agency (KO- TRA) in January 212 show that more than half of the Korean producers operating in Vietnam procure less than 1 percent of their parts and components in Vietnam. In addition, wages are increasing and labor regulations are strengthening in ASEAN countries. For example, Malaysia and Thailand implemented a minimum wage system in 212 and 213, respectively. Thus, the stability and better working environment that ASEAN members offer comes at a heftier price. Figure 5 Working-age Population Share in ASEAN Figure 6 China & ASEAN Factory Workers Salary (%) (times) (US$) China (Beijing) Demographics Bonus Period Share of working-age population (Left) Working-age population/dependent population (Right) China (Shanghai) China (Guangzhou) Malaysia (Kuala Lumpur) Philippines (Manila) China (Dalian) China (Shenzhen) Thailand (Bangkok) Indonesia (Jakarta) Vietnam (Hanoi) Cambodia (Phnom Penh) Myanmar (Yangon) Source: UN, Population division. Source: JETRO (212). Survey database. 64

6 KIM Kyung-Hoon What are the Characteristics of ASEAN Consumers? Solid domestic demand fueled by a burgeoning middle-class population has helped ASEAN compensate for a weak global economy. Private consumption accounted for 53.2 percent of the GDP of ASEAN countries in 212, higher than the 44.6 percent in BRICs. According to Euromonitor, the middle-class population in ASEAN countries will increase to 1 million by 22 from 52 million in 21, with the number of PCs increasing by 5 million, and mobile phone subscribers expanding by 11 million between 21 and 22. The main features of the ASEAN market are that it is relatively less constrained by national borders, as member nations are building an ASEAN Free Trade Area and Economic Community. In addition to its burgeoning middle class and growing integration, ASEAN is characterized by a strong share for young consumers, and (in Malaysia and Indonesia) one of the world s largest Muslim populations. Y-generation consumers (people aged 15-29) stand at 16 million, accounting for 27 percent of the total. This share is higher than in China and Russia at 24 percent and 23 percent, respectively. These teenagers and young adults actively use mobile devices to shop for and acquire information. Social networking services are becoming increasingly popular, with Facebook users in Indonesia and the Philippines standing at 5 million and 3 million, ranking fourth and eighth in the world. Roland Berger, a leading international consultancy, projects the size of the mobile marketing industry to more than double by 216 in Indonesia, the largest ASEAN market, due to the rising use of social media and IT devices. At the same time, the social structures of the past are taking a new form in Kampung culture, which has expanded with the IT boom. Kampung culture (from the traditional Malay and Indonesian word for village or neighborhood ) has moved online, leading to rapid information delivery and credibility for shared information. According to global research firm TNS s 211 survey, younger people in ASEAN were especially positive about brand information obtained on social networks. Along with the online revival of the kampung, Muslims, who account for more than one-third of the ASEAN population, are becoming an increasingly vibrant, assertive and differentiated consumer segment. Demand for halal 1 items, including food and financial products is growing as the region s Muslims assert their desire to live in accordance with Islamic law. ASEAN Muslims strongly prefer global brands, and thus global leading companies are utilizing ASEAN as a test bed. After McDonalds Halal menu succeeded in Singapore and Malaysia, the fast food giant opened a Halal unit in Australia and the UK. Standard Chartered Bank in 212 selected Malaysia as its global hub for Islamic consumer finance, and has strengthened its entry into this market. How Are the Strategies of ASEAN's Ethnic Chinese Companies Changing? Although ethnic Chinese account for less than 5 percent of ASEAN s total population, their capital accounts for a large portion of the ASEAN economy. As of July 211, the total market capitalization of 72 of ASEAN s ethnic Chinese owned businesses was $411 billion, 2 1 Halal refers to items or individual acts that are permissible under Islamic law, and covers everything from dietary matters to personal finance. Alcohol, pork products or the charging of interest on a loan, for example, are not permitted under Islamic law, and are thus not halal. April 213 SERI Quarterly 65

7 The Potential of ASEAN Revisited percent of the aggregate market capitalization of their respective countries. ASEAN s ethnic Chinese companies cast a wide net over the service sector. After World War II, Chinese accumulated capital in real estate and financial firms by building a web of personal connections, or guanxi, and they now also dominate commodity markets. In the past 1 years, China s huge appetite for raw materials has solidified the status of ASEAN s commodity traders. ASEAN s ethnic companies that have strong balance sheets are expected to strengthen their M&A strategies. After the Asian currency crisis, ethnic Chinese companies restructured and bolstered their corporate structure. To prepare for intensifying competition in the ASEAN market and to create a foothold for globalization, ethnic Chinese run firms are now scooping up assets to expand their market share. Thailand s TCC Group and Indonesia s Lippo Group, for example, both competed to acquire F&N, Singapore s largest food and beverage firm. Competition will intensify along with the launch of the ASEAN Economic Community in 215, and ASEAN s ethnic companies that have strong balance sheets are expected to strengthen their M&A strategies. ASEAN s ethnic Chinese run companies who are reaching the upper limits of their growth potential are trying to secure manufacturing technology, while mainland Chinese firms are trying to build distribution networks in ASEAN. This mutual need is spurring the pursuit of joint investments. For example, Thailand s Charoen Pokphand (CP) Group, which operates in the food business, established a joint firm with China s SAIC Motor to manufacture cars from 214. How Competitive are Japanese Companies in ASEAN? Based on their long experience operating in ASEAN, Japanese companies continue to dom- 66

8 KIM Kyung-Hoon inate the ASEAN consumer and infrastructure markets. Japanese car makers account for 95 percent and 9 percent of Indonesia s and Thailand s car markets respectively. Japanese companies have also been heavily involved in energy development, building road and railway networks and upgrading disaster response systems in the region. The Innovation Network Corporation of Japan and New Energy and Industrial Technology Development Organization support Japanese companies in technology development, testing and business reorganization to promote exports of infrastructure packages via consortia. Such efforts have allowed eleven Japanese companies, including Mitsubishi and Hitachi, to participate in a 3.4 trillion Jakarta development project. Aware of the Korean and Chinese companies flocking to the region, Japanese businesses are focusing on further strengthening their ties with ASEAN. After relations with China worsened in the mid-2s, the Japanese government began to increasingly turn toward ASEAN as a partner for trade and investment. Japanese Prime Minister Shinzo Abe has continued this shift, choosing Vietnam, Thailand and Indonesia for his first foreign trip after taking office at the end of 212. During his Southeast Asia tour, Abe announced five principles for his ASEAN policy (including more trade and investment), as well as social and cultural exchanges among young people from both regions. Japanese companies are also reaffirming their commitment as long-term partners for ASEAN s business and community development. After floods devastated Thailand in 211 for example, some foreign companies there considered relocation. Toyota in contrast, reaffirmed its presence by vowing to expand its Thai production. In 212, Toyota observed its 5th anniversary in Thailand with the slogan By Your Side, Always. Japanese companies in ASEAN have also transferred land development technologies and social improvement plans to local society. What are the Issues in Entering Late-comer Emerging Markets? Reform and opening up has ignited investments and growth in Cambodia, Laos, Myanmar and Vietnam, the CLMV countries. Though they account for less than 1 percent of the total ASEAN economy, they have expanded at an annual average rate of 6.1 percent since the 28 global financial crisis. Their total population at 28 percent of ASEAN s total has made the four nations into attractive markets for consumer goods. At the same time, their strategic position between China and the Indian Ocean is well suited to building pan-asian infrastructure; while the Mekong River that connects the nations has the potential to generate 3, megawatts of power. Still, foreign companies entering the CLMV countries cannot expect a smooth landing. Political risks and underdeveloped institutional infrastructure for dealing with foreign businesses can easily upend plans. Comparisons of worldwide governance indicators show that systemic risk in CLMV countries is higher than in the Middle East and North Africa, and they have yet to establish a stable market economic system. Vietnam, the first mover among the CLMV countries, has excessive investments, financially troubled state-owned companies and an unstable banking sector. There is also higher policy volatility, lack of skilled labor and a weak infrastructure in Cambodia, Laos and Myanmar. IMPLICATIONS ASEAN economies are becoming increasingly attractive investment destinations for Korean April 213 SERI Quarterly 67

9 The Potential of ASEAN Revisited Figure 7 Diagnosing ASEAN Economies Will ASEAN Become the World s Workshop? What are the Characteristics of ASEAN Consumers? How Are the Strategies of ASEAN s Ethnic Chinese Companies Changing? How Competitive are Japanese Companies in ASEAN? What are the Issues in Entering Late-comer Emerging Markets? Promising emerging market Fierce competition expected Coexistence of diversity Low Risk High Low Strategy differentiation considering growth stage and risk Brunei Singapore First-mover emerging economies Philippines Malaysia Thailand Growth Capacity Indonesia Vietnam Cambodia Myanmar Late-comer emerging economies Laos High Note: Risk refers to governance index, growth capacity refers to annual average GDP growth rate, and the size of the circle refers to the size of the GDP. Source: World Bank, Worldwide governance indicators DB.; IMF, WEO. firms despite the risks. A strategy that focuses on specific areas and sectors can raise returns, as it will be difficult in the short-term to catch up with Japan in official development assistance and investment in terms of size. In devising their approach, Korean firms will need to consider the diversity in economic development, income levels and business environments among ASEAN s member nations. Late-comers Cambodia, Laos, Myanmar and Vietnam will have high growth but also high risks. The Korean government and companies can frame themselves as solution providers in a collaboration that would produce win-win results for themselves and the CLMV countries. This strategy should support reducing the economic gap with the more advanced ASEAN member countries and strengthening inter-region connectivity. As such, the Korean government and companies need to prioritize forming partnerships based on infrastructure investment and mutual support. This will help gain a foothold for manufacturing plants and entry into CLMV domestic markets. The first-mover member states, including Indonesia and Thailand, have the potential to become the next BRICs, and their vast domestic demand market should be targeted. Korean companies should shift their manufacturing investment strategy in ASEAN from assembling for exports to producing finished goods for domestic demand to tap the rapidly growing consumer market. By promptly responding to the consumption trends of younger generations and Muslims, new markets should be explored while expanding advancement into industrial and social infrastructure, which are expected to expand rapidly. Finally, the government can examine making bilateral free trade deals with major ASEAN countries, which has greater market opening effects than the current Korea- ASEAN free trade agreement. Translation: NOH Si-Yun Keywords ASEAN, BRICs, Kampung, Y-Generation, Halal, CLMV countries KIM Kyung-Hoon is research associate at SERI. His areas of expertise include development economics and regional economic integration. He holds an MSc in Political Economy from the London School of Economics and Political Science. Contact: kyunghoon1.kim@samsung.com 68