Asia scrambles for answer to China's economic ascent

A few days into the new year, the workers of local electronics maker Unico learned the hard way about the brute force of China's industrial revolution.

The Malaysian firm had been providing computer motherboards to chip giant Intel Corp, which runs a big assembly plant just down the road, when a Chinese rival grabbed the contract by offering to do the job for about half the price.

At a stroke, half of Unico's 1,600 workforce was laid off.

"We make very good products -- high quality, fast delivery. Unfortunately, China's running a lot cheaper than us. That's the name of the game," said Alex Soon, Unico's chief financial officer.

It's a game that's being played at breakneck speed across Asia. Hardly a day goes by without a company announcing plans to open a plant in China to tap into the country's unbeatably low labour costs and fast-growing market of 1.3 billion consumers.

For all the dislocations that China's emergence as the workshop of the world is causing, people in Penang at least show remarkably little bitterness toward their neighbour to the north.

"We were in the same position in the seventies as China is today," said K. Veeriah, the Penang secretary of the Malaysian Trades Union Congress. "We've come full circle. A lot of people don't understand the impact that China is going to have over the next five years, but I don't think there's any resentment."

Moving up the ladder

Indeed, if China's rivals respond nimbly by developing new skills, they should be able to carve out niches in higher-margin industries where China cannot compete and take advantage of rising Chinese demand for tourism, health and education services.

Last week, US-based computer hard disk drive maker Maxtor Corp flagged job losses among its Singapore workforce of 8,000 once a $115 million plant it plans to build in the Chinese city of Suzhou comes on stream in 2005.

But a day earlier Mandarin Oriental Hotel Group said it planned a second upscale hotel in Hong Kong to cater to the growing number of visitors from mainland China.

China already has a voracious appetite for energy, commodities, raw materials and equipment to feed its industrial machine, leading Jim Walker, chief economist at CLSA Emerging Markets, to call it the golden goose of the global economy.

Japan believes China has an unfair advantage by artificially holding down its yuan currency, which is pegged at around 8.28 per dollar, and wants a revaluation that would curb its exports and thus boost Japan's own sluggish, export-dependent economy.

But Walker argues that would kill the China goose: cutting China's export income would reduce its demand for imports.

"What we would all rather have -- a moribund but competitive Japan or a competitive and dynamic China? The question is rhetorical because the answer is so obvious," Walker said.

"China is on the move and it is a massive benefit for everyone in the global economy" he said in a note to clients.

Jun Ma of Deutsche Bank agreed: he calculates that China accounted for 65 per cent of total world import growth in 2002.

By 2006 Ma expects China to be consuming more than 20 per cent of the world's production of steel, copper and aluminium on its way to becoming the world's second-largest economy -- it is now number six -- by 2017.

Don't blame China for deflation

Another

fear stoked by the competitive pricing that cost Unico its Intel contract is that China is exporting deflation.

Most economists take the view that a generalised fall in prices is caused by inadequate demand in an economy and say it is a fallacy that China is driving down prices across the globe.

Yes, the price of manufactured goods is dropping, but the prices of palmoil and many industrial commodities are soaring.

"China contributes both inflation and deflation to the world market, depending on the labour intensity of the sectors in question," Ma said in a report. "The net China impact on aggregate world prices is very mild."

That's cold comfort for businessmen in Penang, who say a growing array of imported Chinese consumer goods sell in the shops for less than it costs to make similar products locally.

"How are we going to compete with that? It's a dangerous trend," said Cheah See Kian, who runs a business manufacturing traditional Chinese medicines.

Textbooks say Penang should respond by abandoning low-margin manufacturing and move into more sophisticated and lucrative sectors such as design and development.

This is in fact already happening, but given a local skills shortage and China's own ambitions to clamber up the value-added ladder, officials know the transition will be tough.

Foreign direct investment into Malaysia is being lured away by China, fanning fears that the broad industrial base that Penang has built over the past generation will be hollowed out.

"All the textiles, the plastics, the commodity stuff will all leave, just like they did from the US 20-30 years ago and from Singapore in the last 10 years. So Malaysia is facing it 30 years later -- it's not a surprise," Soon, the Unico executive, said.

No longer the courted maidens

Indeed, rather than taking China head-on in manufacturing, some economists think Southeast Asian countries should play to their strengths and focus on natural resources and tourism.

"That's a more realistic option, if you ask me, than to keep saying we are going to compete with China in manufacturing at the high end, because China is moving fast into the high end as well," said Toh Kin Woon, the Penang state executive councillor for economic planning.

But Daniel Lian, an economist with Morgan Stanley in Singapore, has his doubts. In 2002, manufactured exports from Malaysia, Singapore, Thailand, Indonesia and the Philippines accounted for 54 per cent of the five countries' combined gross domestic product of $566 billion.

Lian estimates that $90 billion of these exports, or 30 per cent of the total, will be lost to China within a decade, while annual receipts from a Chinese-fueled tourism boom cannot realistically exceed $20-25 billion.

"Tourism cannot replace manufacturing," he said in a report.

Maintaining -- let alone raising -- living standards during what Morgan Stanley calls "The Chinese Decade" will thus tax policy makers in the rest of Asia to the limit.

Reforms to clean up bust banks, improve education and allocate capital better will become more important than ever.

"The wave has been and gone. The manufacturing boom is over, for Southeast Asia at least," said Boonler Somchit, executive director of the Penang Skills Development Centre. "China can only grow. We grow old. We are no longer the courted maidens."