The term ‘second China shock’ has been coined to describe China’s changing role in the global economy. China’s aggregation of global manufacturing capacity and progress up technological ladders appears increasingly not as a passing phase in transition to a consumption and services-led economy. Rather, it is a lasting phenomenon that is reshaping the world economy and politics. Few countries will be more impacted by this than those in ASEAN, whose economies are already closely entwined with China’s.
The guiding thread in Chinese economic and industrial policy is to develop ‘new quality productive forces’, based on advancing domestic capacities in science and technology (S&T). The government work report delivered at China’s last legislative session earlier this year prioritised S&T development above GDP growth, and even above the ‘common prosperity’ that Xi has championed to counteract China’s growing inequalities.
This concept of economic progress does not imply autarky, but it does require Chinese industry to move up supply chains to increasingly complex and valuable positions. It privileges the ‘real economy’ and specifically manufacturing, which Xi has said must remain the foundation of China’s economy and not be outsourced to other nations.
Such thinking has been manifest in Chinese policy over decades, whether in a ‘tech crackdown’ that targeted digital services in favour of hardware producers, in fostering ‘little giant’ enterprises that operate across the manufacturing economy, or in building R&D infrastructure to support long-term development of domestic supply chains. By doing so, China’s leaders aim to address the nation’s Achilles heel of dependence on foreign suppliers for core technologies, and to create a sustainable growth model. This project has assumed increasing urgency under various pressures that include ageing demographics, climate change and expanding US measures targeting China’s economy.
China’s decades-long development of its domestic factors of production — which spans infrastructure and logistics, human and institutional capital, and R&D and industrial ecosystems — has created a manufacturing economy that is run by Chinese companies and driven by the scale of China’s internal markets. The Chinese economy in many cases has output capacity exceeding domestic demand, delivering products that are globally competitive on quality and priced below foreign alternatives. The result is long-term structural pressure for Chinese producers to export their surplus, on terms that are commercially attractive but politically antagonistic.
Over 2018-2023, China’s exports of manufactured goods rose 40 per cent, compared to a 15 per cent increase over 2013-2018. China is exporting almost half its manufacturing output, a surplus that now accounts for around 2 per cent of global GDP, comparable to the US after the Second World War. Because Chinese manufacturing has moved into higher value-added and politically important sectors, advanced economies that have previously dominated these sectors are raising walls against the Chinese export tsunami.
Two sectors in point are solar panels and electric vehicles (EVs), the latter now subject to US and EU measures aimed at protecting local industry from ‘unfair’ Chinese competition. The US has also imposed tariffs on solar panels that extend to four ASEAN economies, which are seen as effectively ‘laundering’ Chinese production. Provisional EU tariffs on Chinese EVs reinforce the trend towards rich economies closing their markets to Chinese producers that are now direct competitors to their domestic firms, with significant cost advantages that extend far up the supply chain.
In response, the profile of both China’s exports and outbound investment is shifting from developed to developing economies. ASEAN is the epicentre of this trend, with China providing a third of the region’s manufacturing FDI in 2023. Simultaneously, firms from OECD countries are ‘derisking’ from China by moving manufacturing FDI and operations to ASEAN, although this activity is often still linked to China’s manufacturing sector, given its vast footprint and near-monopoly of various inputs.
This investment shower, and the chance for technological upgrading it entails, might provide ASEAN economies the chance to escape the middle-income trap and the ‘Lucas paradox’ of rich countries hogging global capital. Malaysia’s leader has been most vocal in offering his nation as “the most neutral and non-aligned location” for transnational production, but this aspiration is shared by governments around Southeast Asia. However, the situation also entails challenges as ASEAN policymakers calibrate to the changing circumstances of the ‘second China shock’, driven by high quality Chinese manufacturing seeking foreign export markets.
First, China’s manufacturing juggernaut may crowd out ASEAN firms from entering supply chains, and ASEAN-based production from Chinese markets. Chinese manufacturing’s competitiveness rests on extensive and low-cost domestic production ecosystems. This means that niches in which ASEAN firms can hope to compete will be scarce. In addition, Chinese products manufactured in Southeast Asia may remain more expensive than the same products made within China. ASEAN countries may thus face the old dilemma of restricted pathways to technological upgrading, but with the added problem of local production chasing limited markets, with China supplying itself from domestic output and rich countries shutting out China-linked production.
As the solar panels case highlights, the US at least is likely to adopt measures that punish Southeast Asian states for joining China’s manufacturing economy. Such measures may come to extend beyond access to US markets, targeting China-linked production within ASEAN regardless of the destination. While the EU and other rich economies may not go this far, their derisking efforts vis-à-vis China will have impacts on ASEAN countries integrated with Chinese production networks. Such penalties may take the form of reduced opportunities to participate in production networks centred on the rich economies, although rising protectionism and industrial homeshoring drives may imply this even absent open-door policies in ASEAN towards China.
Finally, Southeast Asia’s rise as a manufacturing location for China and its rivals will drive intra-ASEAN divergence. Five countries (Indonesia, Malaysia, Thailand, Singapore and Vietnam) received almost all the region’s received inbound manufacturing FDI over 2022-23. The other five are unlikely to catch up, especially if output in the leading countries relies on selling to other national markets within ASEAN. Such a two-speed regional economy would exacerbate Southeast Asia’s already uneven level of development, adding to the pressures on ASEAN centrality as a foundation for the region’s politics.