How ASEAN should attract investment

How ASEAN should attract investment

The Chinese challenge to ASEAN in the area of foreign direct
investments will intensify, not weaken, says Susumu Awanohara.

SINGAPORE: Some officials and businessmen in South-east Asia
seem to be clinging to the hope that ASEAN would attract more
foreign direct investment (FDI), now that China has supposedly
lost some of its strengths as a host country. Such a hope was
perhaps more justified before the region's continuing currency
crisis. Perhaps it has some basis even today, but only if the
crisis-induced domestic reform proceeds smoothly within ASEAN, if
ASEAN countries quickly regain export competitiveness after
devaluation, and if China rolls over and plays dead.

ASEAN should not be pinning any hope on a new boom in FDI at
this point, as vastly preferable as this form of capital inflow
now looks to the more fickle ... and as it turned out,
disruptive ... portfolio investment. FDI experts in Tokyo and
Washington largely confirm this view. Here are several reasons
why ASEAN should not be too optimistic.

* ASEAN countries have definitely lost some "pull" as hosts
for FDI in the currency turmoil;

* China has not lost that much pull after all; if anything, it
will become more attractive;

* On the "push" side, major investors in ASEAN ... certainly
Japan and the Northeast Asian NIEs if not the U.S. ... will cut
foreign investment and look hard at destinations other than China
and ASEAN;

* There is a reasonable chance that China will devalue its
currency if its exports slow down significantly.

It is not surprising that Toyota and Honda in Thailand have
virtually halted their operations after the massive baht
devaluation, sharp drops in asset values and the drastic slowdown
in Thailand growth. Industries whose products have a high import
component and are sold domestically are hardest hit by
devaluation. Cars constitute a prime example of such industries
which investors, domestic or foreign, can be expected to stay
away from until the devaluation's effects are dissipated. Some
industries... including electrical equipment and electronics...
will try to shift sales from domestic to foreign markets but this
really entails manufacturing higher-quality products at greater
cost. Many Japanese manufacturers including Matsushita are now
busy switching to export-quality production in ASEAN, according
to AT Kearney's Toshihiko Kinoshita, who for many years headed
Japan Export-Import Bank's FDI research. Theoretically,
industries whose products find a ready international market yet
whose inputs are found domestically may even benefit from
devaluation. Some petrochemicals and agro-based products may fit
this lucky category but there aren't enough of these around.

On the whole, the ASEAN group lost its luster as FDI
destinations following the financial crisis. According to a soon-
to-be-released Japan Exim Bank survey of Japanese investors,
China in 1997 retained the top rank as the "most-promising FDI
destination," whereas Thailand dropped from second to fourth
place, Vietnam from fifth to sixth place, Malaysia from sixth to
eighth place and Singapore from ninth place off the list of top
10. Indonesia managed to remain in third place and the
Philippines rose from eighth to seventh position, however.
Significantly, the U.S. rose from fourth to second spot.

In Tokyo and Washington, sources have dismissed the notion
that China was no longer a compelling FDI destination, although a
while ago there seemed to be good grounds for some South-east
Asians indulging in the all-too-understandable schadenfreude over
China's waning fortunes. Around 1994, some investment from
Hongkong, Taiwan and the U.S. indeed appeared to be shifting at
the margin from China to South-east Asian countries. In addition
to the usual litany of complaints... about the absence of laws
and regulations, lack of transparency, overstretched
infrastructure, dearth of qualified managers and joint-venture
partners, overcapacity and low profitability... there was a
crescendo of alarm that the Chinese were becoming too picky too
soon, restricting or even prohibiting FDI in certain sectors.

Thus, in order to control inflation, the Chinese limited FDI
in real-estate related sectors. To protect the hard-pressed
state-owned enterprises (SOEs), and in measures flowing from a
supposed national industrial policy, the Chinese stopped foreign
investment in low-end labor-intensive industries, slapped export-
performance and technology-transfer requirements and withdrew
duties exemption for import of capital goods. Gloating on their
success, the Chinese had become arrogant and were choking off FDI
coming their way.

That, at least, was the mood among China's multinational
suitors... a mood propagated by the international business
press. But this mood is much exaggerated as the figures prove. To
be sure, FDI committed (or "contracted") peaked in 1995 at more
than US$90 billion and will likely keep declining. But FDI
actualized (or "utilized") continued to climb in 1996 to US$42
billion and is very likely to stay in that range in 1997.
Moreover, as Brookings Institution's China specialist Nick Lardy
points out, there is considerable under-counting of reinvested
profits earned inside China.

There are common-sense reasons why China remains attractive.
Whatever the short-term frustrations, there is no denying that
longer term, China is becoming an easier place in which to do
business. Wages are still much lower than in most of ASEAN.
Export performance requirements, originally imposed to prevent
foreign investors from becoming large users of scarce foreign
exchange, are being eased because convertibility is now allowed
on China's current account and China has huge external reserves,
as Lardy points out. Lardy adds that China's technology transfer
demand has been overblown; it was much more the fierce
competition among foreign investors that forced technology
transfer on them. As U.S.-China economic ties improve, "de-
linked" from human rights, U.S. businessmen will benefit from
improved Chinese attitudes towards them. China's entry into the
WTO will reinforce this trend. The simple, powerful fact is that
China is an enormous and growing market... one place where
international players definitely want to be, regardless of where
else they want to be as well.

So ASEAN is stuck with a magnetic China. Another problem for
ASEAN is that potential investors from Japan and the NIEs will
feel less of the "push" to set up abroad. One reason is that
their currencies have weakened against the US dollar, reducing
the pressure on them to seek lower-cost production sites. More
basically, many companies in North-east Asia will be struggling
for their very survival.

Some FDI providers may be looking hard at destinations other
than China and ASEAN. When these hosts look shaky for any reason,
there is a return to the U.S. and Western Europe. There may be an
FDI rush to Siberia if Japan-Russia ties improve as much as some
in Tokyo believe they will. The earlier-cited Exim Japan survey
shows that in 1997, the position of Asia as Japanese FDI
destination declined from 65.1 percent of total to 59.3 percent,
while "U.S. and Canada" rose from 13.8 percent to 14.2 percent
and European Union rose from 9.9 percent to 10.9 percent.

It is possible that if things go well in ASEAN, the region
will regain export competitiveness vis-a-vis China. But the
Chinese economy is also faced with structural problems ... some
of them quite similar to ones that brought down other East Asian
economies ... as well as a slowdown in domestic demand. Beijing
may not acquiesce in an export slump and a drop in FDI from Japan
and other East Asian economies, including NIEs and ASEAN. Beijing
will not be forced to devalue in the immediate future (there is
no capital account convertibility, thus the yuan will not come
under speculative attacks). But Beijing may devalue on its own
accord, wiping out ASEAN's competitive gains, President Jiang
Zemin's assurances to the contrary notwithstanding.

Yet, clearly, the Chinese challenge in trade and investment
will intensify for ASEAN. China is such a huge and varied economy
that its industries can achieve economies of scale before
venturing out and the country can embrace a whole spectrum of
industries... from low-tech to high-tech... all at once, making
it difficult for competitors to find a niche. Liberalizing intra-
ASEAN trade quickly is a step in the right direction but it will
not be enough. ASEAN may need an investment promotion strategy.

Susumu Awanohara, a former journalist, is research adviser and
editor of Capital Trends (www.gwjapan.com/nrca) at the Washington
office of Nikko Research Center, Ltd.