While China may not be investing substantially directly in manufacturing in its Asian neighbors, as Japan did in the 1980s, the region is benefiting nonetheless from investment in Asian production bases because of the spillover effect of rising labor and production costs in China itself, according to two studies* released last week by the Hong Kong Trade Development Council. That phenomenon appears almost certain to increase.

Rising production costs have been playing themselves out in a series of damaging stories over the past few weeks in China as striking workers shut down four Japanese-owned Honda plants to demand better working conditions and pay, and at least 10 workers have committed suicide in plants owned by Foxconn, which manufactures electronic equipment for top US multinationals including the Apple and Dell computer companies. The huge Foxconn plant in Shenzhen employs 400,000 workers.

As a result of the publicity over the suicides, Foxconn's parent company, the Taiwan-based Hon Hai Precision, announced it was raising minimum wages by 30 percent. That is almost certain to put heavy pressure on other manufacturers in the Pearl River Delta to raise wages and provide better working conditions to the millions of migrant workers who have flocked to the Delta plants.

Pearl River Delta-based manufacturers are viewing Foxconn's wage raises with something akin to alarm. The TDC reports indicate that more than half of the companies the agency surveyed in 2009 suffered labor problems, despite the fact that hourly wage costs have risen by 17 percent over the last six months. In addition, average world metal prices have increased by 120 percent since February of 2009.

"In most cases," according to the TDC, "manufacturers have already offered more than the minimum wage to attract new workers or retain existing ones. However, the increase in minimum wages has reinforced workers' expectations of further wage hikes. This has exerted pressure on manufacturers to raise wage levels in order to maintain a stable workforce and has created new difficulties in human resources management."

Classically, when production costs make a move attractive, multinationals show no compunction about getting up and going, as governments that opened tax-free manufacturing zones across Asia learned to their sorrow from the 1980s onward. And, although the number of Chinese-based manufacturers – including Korean, Hong Kong and Taiwanese ones -- that have chosen to move out of China has been just a trickle at this point, these pressures may well accelerate the movement. Because of its geographical proximity and relatively sophisticated work forces, Southeast Asia can expect to be a beneficiary. The region made a major leap in industrialization after the Plaza Accord of 1985, signed by five major governments, resulted in a dramatic revaluation of the Japanese yen. As a result, Japan manufacturers rushed into Southeast Asia, particularly electronics manufacturers, and created a boom that pulled the region out of a major slump.

The Chinese usually – although not always – center their official investment into fields that play into their own needs, usually by state-owned companies, most of it to fit their own voracious requirements for inputs such as coal, oil, timber and foodstuffs. From 2004 to 2008, investment in agriculture, forestry, fisheries and husbandry rose from US$288 million to US$1.718 billion. Foreign direct investment in mining went from US$1.8 billion to US$5.823 billion.

According to the latest report on foreign direct investment by the United Nations Commission on Trade and Development, although FDI from China rose 132 percent in 2008, the last year for which records are available, it only reached US$52 billion. Despite its status as the world's second-largest economy, China still ranks only 13th in the world as a source of FDI.

As prices have risen for manufactured goods because of labor and production costs, emerging production bases are beginning to produce cheaper and less sophisticated cost items as the Chinese move upstream for higher value added products.

According to the TDC reports, while the overall market share of manufacturers in countries such as Vietnam and Cambodia remains small, individual product such as certain kinds of textiles and clothing have been growing in value, enhancing FDI in those countries.

The labor cost differentials have impelled some buyers and manufacturers to restructure to take advantage of the lower costs. The report quotes a Japan External Trade Organization survey in 2009 giving annual actual wage costs in China for manufacturing workers at about US$4,000 a year. By contrast, JETRO found Japanese companies were paying about US$2,000 in Vietnam and US$1,000 in Bangladesh.

The United States remains a major import partner for the region despite the economic turndown that began in 2008. US import items from Vietnam and Bangladesh comprise mainly basic items such as cotton pullovers or sweatshirts, according to the reports.

The report points out that while Southeast and South Asian countries can offer lower costs in supplying simple items in bulk orders, the Chinese have become sophisticated enough to hold onto the trade for items requiring higher skill levels, sophisticated design and those requiring quick turnaround time. Labor productivity in China continues to be significantly higher than that in Vietnam, Cambodia or Bangladesh.

But there is nothing that says Southeast Asian countries can't scale the technological ladder, as China did. Malaysia and Singapore in particular are seeking to reconfigure their economies to move up the value-added scale.

In any case, as Asia Sentinel reported on May 7, 2010, both trade and investment in Asean are expected to pick up noticeably with signing of a free trade agreement with China on 1 January 2010. Sundram Pushpanathan, an Asean Deputy Secretary-General told the ASEAN Roundtable 2010 last week that ASEAN-China trade reached over US$192 billion last year, and is growing annually between 24 percent to 30 percent. After normalizing relations with Vietnam, China's invested capital reported in licenses went from US$120 million in 1999 to US$2,673 billion, an eight-fold increase in the number of projects and a 22-fold increase in registered capital.

The Statistical Bulletin of China's Outward Foreign Direct Investment only goes up to the end of 2008, and the anecdotal evidence is that major outflows really began in 2009.

*The Competitive Supply Chain: China vs. arising Asia, Hong Kong Trade Development Council, June 2010

*Mounting Price Pressure on Chinese Exports, Hong Kong Trade Development Council, June 2010