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12 November 2015

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Buavanh Vilavong is a PhD candidate at Crawford School of Public Policy and one of the speakers at this year’s Crawford PhD Conference. Find out more about the conference here.

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Some countries in Southeast Asia have economically benefitted from the emergence and proliferation of production networks, but for others there’s still work to do, writes Buavanh Vilavong.

The emergence and proliferation of production networks has shifted the centre of gravity of international trade, and nowhere in the world has benefitted more from this change than the Association of Southeast Asian Nations (ASEAN).

Thanks to improved production and communications technologies, the production process can be sliced up and located in various countries to take advantage of locational differences, such as available labour.

Production networks constitute almost 80 per cent of manufacturing exports of ASEAN, an increase from 57 per cent in 1990 according to the United Nations Comtrade. Low wages and, to a larger extent favourable trade and investment regimes, have contributed to ASEAN’s successful integration into international production sharing.

The origin of production sharing dates back to the late 1960s when a couple of multinational corporations (MNCs) based their semiconductor assembling plants in Singapore. By the 1980s, Malaysia, Thailand and later the Philippines had followed suit in tapping into the electronics production chain. Today, the region’s engagement in production networks has been much diversified, ranging across all sectors from garments, to electrical appliances, to automobiles, and all points inbetween.

But despite this success, ASEAN appears to exhibit two faces in production networks.

On one side, the countries with the longest involvement in production sharing show the region’s dynamic face. Around 60 per cent of firms in Malaysia and Thailand are involved in production networks, chiefly in the electronics and automobile industries. Singapore has even managed to move up the value chain to become a service hub, including in areas such as research and development.

On the other side, ASEAN also has some of the weakest links. It is only recently that Cambodia and Laos have begun to take part in production networks. And the involvement of these countries is at the low value-added segment of production, like garments.

Interestingly Vietnam, though a new ASEAN member, has caught up well. The country not only has a large pool of hard-working workforce but it also creates relevant policies to attract quality foreign direct investment (FDI). Vietnam joining the World Trade Organization in 2007 also helped boost investor confidence in investing more in the country. It’s also interesting to note that size doesn’t matter.

Despite being the biggest economy in Southeast Asia, Indonesia still lags behind in participating in production networks. While the country is linked to the low-cost suppliers in the region, its production is mainly to serve the domestic market rather than export. Key factors behind this are unfavourable investment policies along with high transport costs and labour market rigidity.

One takeaway from the ASEAN experience is that ‘cheap labour’ is not necessarily a decisive cause in attracting FDI. While labour cost is important, other factors such as the business environment, technological capabilities, infrastructure, and a host of other relevant policies, usually determine locational decisions of MNCs.

Take the business environment as an example: Singapore is ranked first as the most business friendly country in the 2015 Doing Business survey. Malaysia and Thailand are in 18th and 26th ranking; far higher than Indonesia in 114th place. Malaysia and Thailand are much smaller than Indonesia, yet they perform better in integrating into the global supply chain.

Another factor is technological capabilities. Initially, some ASEAN governments were concerned that many MNCs might leave their countries and move to the ‘Factory Asia’ countries like China. Over the years, these concerns have proven unfounded. Indeed, Singapore has actually shifted away from standard assembly production, and turned itself into a services hub thanks to policy emphasising technological upgrade, expanding the human capital base, and infrastructure development.

With rising costs in China and the diversification strategies of multinationals, countries with cheaper wages such as Vietnam and other new ASEAN members are expected to benefit from production relocating. This relocation process should not be taken as a given though; it will require these countries to take policy reforms seriously.

Cambodia and Laos are ranked 135th and 148th respectively in the ease of doing business, while Myanmar is all the way down at 177th. One example of why is that traders take 23 days to complete export documentations in Laos, compared with 11 days in Malaysia. As a result, the costs to export in Laos are recorded as high as US$1,950 per container, compared to only US$525 in Malaysia. Such high costs may be partly attributed to Laos being a landlocked country, but policy barriers also matter a lot.

This highlights that it is a priority for new ASEAN members to improve their business environment, particularly on trade facilitation, if they are to successfully integrate into this shifting base of international production and take a larger share of the sharing spoils.

This article was first published at Policy Forum, the website of the Asia and the Pacific Policy Society based at Crawford School. The article is based on an upcoming presentation from the author at the annual Crawford School PhD Conference on 24 November 2015. This annual free to attend event brings together some of the school’s PhD scholars with major international speakers who will this year look at the future of regional groupings among Asia-Pacific countries: https://crawford.anu.edu.au/news-events/events/6157/crawford-school-phd-conference-2015-friends-and-partners-future-regional

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