The consequences of China’s economic development for the West, and the United States in particular, are being closely watched. But the impact of China’s growth for its neighbors is no less important. Over the past decade, North Asian economies that are higher on the economic value chain like Japan, Taiwan, and South Korea have benefited from China’s low-end-manufacturing strengths. Meanwhile, Southeast Asian economies, more closely resembling China and offering similar comparative advantages, have often found themselves outmuscled more recently by their much larger neighbor.

Looking to the future, both China and Southeast Asia will seek to climb the economic value ladder—indeed, China is doing so even now. In the process, Beijing and Southeast Asia will increasingly challenge both the North Asian economies and those of the West.

A Mixed Bag for Asia

A decade ago, as East Asia emerged from financial crisis, China’s rise was viewed by many neighbors as a potential threat rather than an opportunity. But when economies from South Korea to Thailand revived and the regional production-sharing network matured, everyone seemed to benefit from China’s demand for specialized components and primary products. Processing trade—that is, importing raw materials or components for mainland assembly and processing then exporting the finished products—drove China’s trade growth, accounting for its entire balance of trade surplus, while “normal trade” usually generated a net deficit (see Figure 1).

Yet over the next decade, a split emerged in how China’s growth affected North Asian and Southeast Asian economies. Bilateral trade figures illustrate the emerging differences. Between 2000 and 2010, the North Asian trio of Japan, Taiwan, and South Korea saw its collective trade surplus with China (mirrored in China’s trade deficits with these countries) soar from $30 billion to $210 billion (see Figure 2). This growth came from exporting technology-intensive components to China, which provided an assembly base for the finished products ultimately destined for the West.

In doing so, the North Asian economies avoided American-led criticism of unfair Chinese competition, even as they in fact contributed to a large share of China’s contentious bilateral trade surpluses with the United States and the European Union. Australia, another major beneficiary, saw its trade surplus jump from almost nothing in the early part of the last decade to $35 billion in 2010, reflecting China’s voracious appetite for raw materials.

The story for ASEAN countries is more complex, given that their resource endowments are similar to China’s. Immediately after the Asian financial crisis, the region benefited across the board. Its overall trade balance with China shifted from a deficit in the late 1990s to a surplus of nearly $20 billion by 2004.

But by 2009 this surplus had slowly evaporated as Vietnam and Singapore moved to significant deficits and the surpluses of other countries moderated as their imports of finished products and construction-related equipment from China accelerated. More recently, there has been some bounce-back largely due to Malaysia’s unique mix of exports, including both commodities and electronics components, as demand rebounded in the West (see Figure 3).

Trying to Keep Up with a Giant

Evolving regional production patterns have, moreover, affected capital flows, investment rates, and wage trends in ways that have benefited some East Asian countries more than others. China’s industrialization process will likely still be an opportunity for the more developed North Asian economies, which have managed to strengthen their position at the high end of the consumer electronics and IT product lines. But it is affecting investment and labor markets in Southeast Asia in ways that are complicating the subregion’s efforts to moderate widening income disparities, increase productivity, and possibly escape the middle-income trap.

Real wages have stagnated in the Southeast Asian economies as a result of relatively low productivity growth and pressure to stay competitive with China’s labor costs. The ASEAN countries have also struggled to boost private investment rates closer to pre-Asian crisis levels in order to sustain long-term growth. For these two indicators, China is in a class by itself.

Starting in the mid-1990s, real wages in China surged by over 12 percent annually (see table below). Breaking this down by sector, growth ranged from around 8 to 10 percent annually in manufacturing to 15 percent in financial services. By contrast, real wage growth for the middle-income economies of Thailand, the Philippines, and Malaysia was in line with GDP growth for much of the 1990s but then fell off sharply and either declined or stagnated over most of the past decade.

Growth in Real Wages
(% annual increase)
  2000-2005 2006-2009
China 12.6 12.7
Malaysia 3.5 1.1
Philippines -1.1 -0.7
Thailand -1.0 1.2
Source: International Labor Organization


China’s share of investment to GDP, meanwhile, rose steadily from 35 to more than 45 percent over the past decade and a half. By contrast, investment rates never fully recovered in Southeast Asian economies after the Asian financial crisis, remaining about one-third lower than in the late 1990s at around 20 to 25 percent of GDP compared with as high as 35 to 40 percent earlier. Some of this decline was desirable given elevated pre-crisis levels, but the pendulum has swung too far in the opposite direction.

Stagnant real wage growth and relatively low investment rates have been viewed as largely the result of country-specific conditions. But the region’s production network has played a significant role in enabling China to pull away from its Southeast Asian neighbors. With multinational firms managing decisions about where components are produced, location is influenced by the relative productivity of labor and wage costs along with the logistical advantages that China’s size offers. That means China both attracts the lion’s share of investment and sets the bar for labor costs.

China’s exceptional investment rates have contributed to industrial labor productivity’s estimated 10 to 20 percent annual increases since the mid-1990s—much higher growth than its neighbors have experienced and exceeding manufacturing wage increases.1 High labor productivity growth added to the advantages China could provide for labor-intensive assembly lines after its WTO accession in 2001. And there was also ample room for importing medium-tech components from Southeast Asia, which was supported by investments from multinational firms that were driving production-sharing arrangements.

Over time, however, China’s declining unit labor costs have put pressure on countries like Malaysia to limit wage increases in order to maintain competitiveness within the production chain. Failing to do so would mean that these product lines would likely migrate to lower-cost centers in Vietnam, South Asia, or back to China.

Moving Up the Ladder

Meanwhile, China has been aggressively upgrading its technological capacity while its infrastructure base has solidified. Thus even with rapid wage growth, China has been able to strengthen its position in more skill-intensive production lines, though its competitive advantages in more labor-intensive products such as footwear have declined with more recent wage escalation. And in a few cases, production has moved to countries where costs are lower.

Location considerations within China are also coming into play. With the rising cost of production along its coast and an expanded interior transport network, firms like Honeywell and Acer have been moving inland, though some are considering locations abroad in order to target external markets or take advantage of cheap labor.

Surging energy prices, which increase transportation costs, and the complexities of a dispersed supply chain are also encouraging some firms that previously outsourced components to Southeast Asia to relocate their operations and associated R&D activities within China to places like Chongqing or Henan. Intel and Dell are two examples. Moreover, as Chinese technology-intensive companies like Huawei expand, local linkages have deepened.

Thus, processing-related imports have fallen from over 40 percent of China’s total imports to 30 percent over the past decade. And as a share of its exports, they have declined from 55 percent to about 40 percent as production has become more integrated within China. As its economy matures, more and more parts of the production network are consolidating within or moving to China.

Ultimately, both China and the middle-income Southeast Asian countries face the same challenge: becoming more innovative to achieve high-income status. They all realize that they have no alternative but to move up the value chain—with all the requirements that this will entail, from reoriented education systems to globally linked research networks and open innovation systems. If they are successful, they will eventually encroach on the domain of the North Asian trio and heighten competitive pressures in East Asia more generally.

[This piece was expanded from an op-ed, “In the Middle Kingdom’s Shadow,” that originally appeared in the Wall Street Journal on March 27, 2012.]

Yukon Huang is a senior associate at the Carnegie Endowment for International Peace and a former country director for the World Bank in China.

[1]. Estimates of labor productivity done by the World Bank, WTO, the Conference Board, and UNCTAD vary from 10 to 20 percent depending on industrial classification, concepts applied, and data sources.