The Debate

The Political Hazards of Economic Decoupling From China

Recent Features

The Debate | Opinion

The Political Hazards of Economic Decoupling From China

Southeast Asian nations are promising candidates for firms seeking to relocate manufacturing operations from China, but investors need to be prepared for the risks.

The Political Hazards of Economic Decoupling From China

An aerial view of a Honda factory in the industrial outskirts of Hanoi, Vietnam.

Credit: Depositphotos

With tensions between the United States and China showing no sign of abating, more and more businesses are reconsidering their investments in China, contemplating what has been referred to as a “decoupling” from the world’s largest exporter. For numerous reasons, companies from the U.S., European Union, and elsewhere are looking to new markets to serve as manufacturing hubs and commodity suppliers. While the COVID-19 pandemic highlighted the risk of relying on one country for crucial imports, Western corporations doing business in China were complaining long before then of abusive practices such as IP theft and forced technology transfers. China’s increasing assertiveness on the world stage, coupled with allegations of human rights abuses in Xinjiang and Hong Kong, have escalated the trade war with the United States as shown by recent federal legislation such as the Uyghur Forced Labor Prevention Act and the Biden administration’s semiconductor export controls, which compel Western companies to reevaluate their business ties with China.

As decoupling advances, Southeast Asian nations have been among the primary beneficiaries. In 2021, foreign direct investment in the Association of Southeast Asian Nations (ASEAN) soared by 42 percent, reaching an all-time high of $174 billion, according to the ASEAN Secretariat. Meanwhile, China’s State Administration of Foreign Exchange and Ministry of Commerce, which reported strong foreign direct investment through most of the pandemic, have seen inflows drop significantly since the second quarter of 2022. Apple, Samsung, Nike, and Adidas are just a few of the major brands to shift production from China to Southeast Asian countries in recent years.

ASEAN nations offer many advantages, such as young populations, high economic growth rates, and lower labor costs. Yet foreign investors face obstacles: Political instability has long been rife in Southeast Asia’s prime investment destinations, working conditions lag behind those of the West, long-established domestic firms rule the marketplace, and corruption is endemic.

In recent years, Thailand has been rocked by violent street protests demanding democratic reforms. Two opposition parties representing many of these demonstrators – Move Forward and Pheu Thai – appear set to capture the most seats in Thailand’s House of Representatives following the election on May 14 and have agreed to form a coalition government. However, it remains to be seen if the progressives can overcome entrenched interests in the Senate and turn the page on nearly a decade of military and military-backed rule.

Similarly, a Malaysian political crisis that began in 2020 may have ended with the victory of Prime Minister Anwar Ibrahim in November of last year, but the government’s stability now hinges on a coalition of strange bedfellows and it is far from certain that Anwar has the political capital to end the instability of the last few years. As Indonesia gears up for a presidential election in June 2024, some fear that President Joko Widodo will find a way to postpone the polling, dealing a serious blow to democracy in Southeast Asia’s most populous country.

In Vietnam, which is in the midst of an anti-corruption campaign, President Nguyen Xuan Phuc was forced to resign in January, becoming the highest-profile figure to be caught up in the crackdown that felled two deputy prime ministers several weeks earlier. As with Chinese President Xi Jinping’s long-running anti-graft campaign, analysts have expressed concerns that Vietnam’s crackdown has been manipulated by powerful party figures to dispose of political opponents, something that would likely deter foreign investors.

Legal protections for workers in the manufacturing and commodities sectors are weak across Southeast Asia, and while working conditions may not have fallen to the depths of the forced labor occurring in Xinjiang, poor standards are widespread. In Indonesia’s booming palm oil sector, activist groups have documented exposure to hazardous chemicals, payments below the minimum wage, and the repression of labor unions. In Vietnam, the Communist Party has outlawed independent labor unions, a policy the Biden administration’s Department of Labor recently criticized. A lack of adequate protections led to hundreds of thousands of Vietnamese workers being confined to their factories for months on end as part of COVID-19 control efforts.

To make a viable foray into Southeast Asia, foreign investors must also confront entrenched local firms that dominate the market. In Thailand, three major conglomerates – Charoen Pokphand Group, TCC Group, and Central Group – exert significant control over key sectors, such as telecommunications, banking, and retail. Similarly, Indonesia is home to a triumvirate of powerful conglomerates with strong government connections: the Salim Group, Sinar Mas, and Djarum. These conglomerates often receive preferential treatment from regulators and are able to outmaneuver foreign firms that may be hindered by local content requirements and restrictions on foreign ownership. While major initiatives to attract foreign investors are underway in ASEAN’s two largest economies – the Eastern Economic Corridor special economic zone in Thailand and the passage of Indonesia’s Omnibus Law on Job Creation – fundamental challenges remain.

One of the most entrenched barriers to entry in Southeast Asia is corruption, as shown by the fact that the rankings of ASEAN’s major economies in Transparency International’s Corruption Perceptions Index have remained largely unchanged for years. Perversely, efforts to tackle systemic corruption may have exacerbated the problem. Reforms to Indonesia’s Corruption Eradication Commission, the country’s vaunted anti-graft investigator and prosecutor, have stripped it of its independence and undermined its effectiveness. In Vietnam, a wide-ranging anti-corruption campaign has paralyzed bureaucrats who fear being targeted for approving license and permit applications submitted by foreign investors.

Given these pitfalls, foreign investors looking at Southeast Asia would be well advised to ensure they have an effective market entry plan that includes a synoptic assessment of the existing policy environment, supply chain mapping, risk mitigation strategies, and local partner identification. First, a full understanding of the policies governing any given sector – and knowledge of how these strictures may change with elections or cabinet realignments – will help ensure compliance with local laws and may help identify opportunities.

Second, by identifying and vetting each supply chain link, foreign investors can duck serious legal and reputational risk by avoiding parties engaged in nefarious practices, ranging from human rights abuses to money laundering. Third, investors need to identify extant threats to business goals and develop mitigation strategies – such as diversification or risk transfer to third parties – to achieve those goals.

Lastly, partnering with a local firm that understands the market is not just a sound business strategy in Southeast Asia; it is often a requirement. Selecting and properly vetting such a partner, and ensuring shared objectives and values, is crucial to the success of the venture. Foreign investors would be well served to retain a firm with a dedicated political risk and strategic intelligence practice led by specialists with years of public policy experience in the region. Navigating the investment hazards of Southeast Asia is challenging. There is no need to go it alone.