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.