The talk making the rounds everywhere about a "trade war" between the world's two largest economies began early this year when the United States imposed tariffs on solar panels and washing machines against cheaper versions from South Korea and China. By midyear, China became the US' principal target in a wider and more intense tit-for-tat tariff spiral. Seen in this light, the trade war between the two giants was always going to be about a broader geopolitical and geoeconomic tussle, much more than just about trade. The early effects of the US-China confrontation are now evident and will manifest more clearly and widely next year and beyond. As some of the US multinationals in China turn elsewhere, Southeast Asia will be poised for short-term gains, although longer-term prospects bear risks.
Even though the US-China rift is broader than trade, the tariff escalation on both sides has been conspicuous. With a trade deficit in China's favour to the tune of US$375 billion in 2017, the US has slapped several rounds of taxes on Chinese imports -- $34 billion in July and $16 billion in August and a whopping $200 billion in September. These tariff walls ranging 10-25% may soon be expanded to cover the entire $505 billion worth of what China sells to America.
China has retaliated in equal frequency, but in lesser measures because its imports from America are much lower, at $129 billion. Although consumers on both sides will ultimately be worst off due to higher prices and/or inferior goods, the US has more leeway to levy tariffs on China because of the lopsided trade flows. In turn, what the US has done is to essentially undermined the "Made in China 2025" growth strategy, which is to increase Chinese local content up to 70% by the targeted year. The notion that China is the "factory of the world" is now problematic.
As global attention and anxiety were fixated on tough trade posturing between Washington and Beijing, it may have been Alibaba Chairman Jack Ma who first put it publicly what many had suspected all along. Last September, he said the two giants' trade war "could last 20 years". Any trade war that goes on that long is no longer about trade and more about war.
Soon after Mr Ma, others began to chime in and a consensus coalesced that the US-China face-off has broader underpinnings rooted in a geostrategic competition and confrontation that was bound to come. US President Donald Trump's emphatic and repetitive language about China's theft of US intellectual property and generally unfair trade practices have intensified. Most recently, Vice President Mike Pence in a speech at the Hudson Institute on Oct 4 referred to China's use of "whole-of-government" to acquire advantageous trade benefits.
Indeed, the US-China showdown in the months ahead is likely to intensify. Beyond tariffs, the US has defiantly demonstrated military force along the contested Taiwan Strait and freedom of navigation operational patrols in the South China Sea.
At home, US authorities are calling out China for intellectual theft and cyber interference. It has reached a point where some have advocated expelling native Chinese students, who number several thousand, from American soil. It is not just the US that is pushing back hard against China. So have Australia and, to a lesser extent, New Zealand. And popular backlashes against Chinese investment and overall presence are evident from Malaysia and Sri Lanka to Zambia.
As China comes under more economic pressure, some of the US firms there are rethinking their business strategies. The tariffs on Chinese exports to the US means that any business that has benefited from relocating their manufacturing activities to China in the past decade will have to reconsider their value chain configuration, which refers to the entire range of activities across industries that bring a product or service from inception to end use. This value-chain rethink is particularly concerned with how to source the extensive and interactive network of suppliers across industries that reside across countries, otherwise known as supply chains. In the short term, firms will look at alternative locations to serve as manufacturing and exporting platforms and to circumvent the US tariffs imposed on exports from China. This is where Southeast Asia comes in. Having also followed the export-led development model, countries like Malaysia, Thailand, Singapore, Vietnam, and Cambodia, have also attracted investment in export-led industries that are also common in China and can therefore become alternatives and substitutes for the China-plus-one supply chain reconfiguration of industries affected by the increased US tariffs.
One country that appears to benefit from supply chain relocation away from China is Vietnam. Its geographical proximity to China, market access to Asean, favourable trade terms with the US, and role in regional agreements and trade pacts like the Comprehensive Progressive Trans-Pacific Partnership stand Vietnam in good stead. Its relative political stability, young and growing labour pool, and relatively lower costs compared to neighbours such as Malaysia, Singapore and Thailand, made Vietnam a leading contender even before the US tariff hikes.
Since 2015, Vietnam has been the third largest investment destination in Asean, behind Singapore and Indonesia but ahead of Thailand, according to the United Nations Conference on Trade and Development. The amount of foreign direct investment flows into Vietnam from January to September 2018 is estimated to be $13.25 billion, up 6% on the same period a year earlier, according to the country's Ministry of Planning and Investment.
Relocation of supply chain activities to Vietnam is likely to be most pronounced in more basic industries such as wood product furniture, textile and apparels. For more sophisticated industries with more complex supply chains, such as automotive and electronics, we may see the shift of activities with lower value-added in the realms of production and assembly, as an initial response in supply-chain adjustment.
However, the situation may not remain that rosy in the medium and longer term. Vietnam's limited physical and legal infrastructure, relatively under-developed supply chains and supporting industries may restrict its ability to absorb more higher-end activities in the value chain. Moreover, the potential disruption in the supply chain of global industries that are likely to incur higher costs will lead to a rethink in the future supply chain strategy among multinational companies. A shift toward shorter supply chains with more firms relocating nearer to their major markets may see part of the production activities heading towards the US, Canada or Mexico, resulting in less inward foreign direct investment in Southeast Asia.
This potential outcome is enabled by advances in production technology driving automation and taking away cost advantages that have been one of the key attractions of emerging economies. While these developments are still far ahead, multinational firms that need to rethink their global value chain configuration will certainly take these into consideration for their longer-term supply chain management.
In short, the US-China trade war is now in full swing with growing repercussions for affected firms and countries. Some of the US's manufacturing may well return to North America as Mr Trump pledged but it may be achieved with higher costs and/or inferior quality of goods and services.
The potential economic slowdown of the US and China as a result of their trade friction could adversely affect countries that trade substantially with either or both countries.
For Southeast Asia, the investment diversion from firms opting out of China is a short-term benefit for countries that offer the right mix of location, demography, operating costs, regional trade agreement, political stability, and clear policy directions, such as Vietnam. There is much to ponder here for Thailand, as its authorities have yet to grasp and come to grips with the daunting challenges facing the Thai economy from the US-China face-off.
Pavida Pananond, PhD, is Associate Professor of International Business at Thammasat Business School. Thitinan Pongsudhirak is director of the Institute of Security and International Studies at Chulalongkorn University's faculty of political science.
