If not China, where? Asia’s next export powerhouse

Rising costs and sweeping tariffs are eroding the appeal of manufacturing in China. The question for many global companies is, where else is there to go? To answer that, Bloomberg Economics created an index of export potential ranking the main Asian contenders on key attributes from labor costs and infrastructure to business environment and political stability.

What the results make clear is that no single economy has the wherewithal to step into China's shoes. Many have a low-cost advantage. With the exception of India, all lack China's scale. And all face challenges on other aspects of competitiveness. The most likely scenario: China retains overall dominance, with other countries gaining ground in particular market segments.

Overall Rankings of Asian Exporters

Source: Bloomberg Economics

Based on the results of our analysis, we classify Asia's aspiring exporters into three groups:

• The leading contenders -- India and Indonesia -- have large workforces and low costs in their favor. Shortfalls on infrastructure, export capacity, and, in India's case, stability, are significant barriers to overcome.
• The chasers -- a group that includes Malaysia, the Philippines, Thailand, and Vietnam -- don't have the scale to replace China. Educated workforces and enabling business environments mean they will continue to claim market share in specific product segments.
• The long shots -- Bangladesh, Cambodia, Myanmar, and Sri Lanka -- have low costs but lag considerably on infrastructure, business environment, and institutional strength. With the exception of Bangladesh, they also lack scale. In the immediate future, they'll stay focused on low-value-added goods.

A striking takeaway: Size and cost are important, but they're not everything. Despite its population of 160 million and cheap labor, Bangladesh scores low on our index. Labor costs in China's Guangdong province, which we use as a proxy for China given its more comparable scale, are no longer particularly competitive. Yet other strengths mean it remains an export powerhouse, and is more competitive than the aspiring Asian economies in overall terms.

Multidimensional Export Competitiveness

In determining which countries will benefit from diversification away from China, we ranked the Asian challengers across six dimensions:

• Export capacity: Economies of scale were a significant factor in China's rise. In our index, export capacity is measured by the size of the manufacturing sector, the size of merchandise exports, and the share of non-raw material exports.
• Human capital: A competitive manufacturing sector requires a big, skilled labor force. To track this, we use working-age population and the human capital index from the Penn World Table.
• Labor cost: Even before trade tensions with the US flared, rising labor costs were pushing companies to look outside China. In the absence of comparable wage data across countries, we use gross domestic product per capita as a proxy.
• Infrastructure: High-quality infrastructure is critical in production and to get goods to market. Our index includes a measure of port and air freight capacity.
• Business environment: An enabling environment is a prerequisite for attracting foreign investment and for development of dynamic homegrown firms. We use two indicators from the World Bank -- the Logistics Performance Index and Ease of Doing Business Index.
• Stability: Economic stability and institutional strength provide certainty for business. We use growth volatility adjusted by growth rates to gauge economic stability and the World Bank's Government Effectiveness Index to measure institutional strength.

We use these criteria to assess 10 economies -- Bangladesh, Cambodia, India, Indonesia, Malaysia, Myanmar, the Philippines, Sri Lanka, Thailand, and Vietnam. China's enormous size would skew comparisons in many dimensions. As such, for scale indicators -- manufacturing size, merchandise exports, workforce, and infrastructure capacity -- we compare other countries not with China as a whole but with Guangdong province. For quality and cost indicators, we use China's national figures.

In each case, data are normalized on a zero-to-1 scale. The six sub-indexes are a simple average of their component variables. For the calculation of the overall index, we assigned an equal weight to each of the sub-indexes.

The Leading Contenders

Source: Bloomberg Economics

The leading contenders -- India and Indonesia -- have similar advantages: enormous scale and low costs. Infrastructure and export capacity are major challenges for both.

India tops our index. Its working-age population of almost 900 million is in line with China's and -- in contrast to China's -- continues to grow. Its labor costs are only one-fifth the level of its big neighbor's.

Prime Minister Narendra Modi is well aware of the opportunities at hand. He's moving to address India's ragged or absent infrastructure and pushing an ambitious "Make in India" plan aimed at transforming the country into a manufacturing hub. The decision by Apple Inc. supplier Foxconn to begin assembling top-end iPhones in India suggests the country is taking steps in the right direction.

Even so, red tape remains a major impediment. Onerous regulations on land use and the hiring and firing of workers are a marked contrast with the situation in China. India also faces challenges in other areas -- it's near the bottom of the pack on education and stability.

Indonesia's working-age population is about one-fifth India's, and its labor costs are almost twice as high. It makes up for those handicaps with stronger education and a more stable macroeconomic environment. President Joko Widodo is steering policy in a favorable direction, with plans to accelerate reforms, develop infrastructure, and ease foreign investment limits in his second term.

Chasers and Long Shots

In varying configurations, countries in the chasers group -- Malaysia, the Philippines, Thailand, and Vietnam -- are stronger in education and business environment among the group assessed. And all are already deeply integrated into Asia supply chains. For Malaysia, the Philippines, and Vietnam, electronics comprises more than a third of their exports (Samsung Electronics sources more than half of its global smartphone production from factories in Vietnam). Thailand is Southeast Asia's automotive hub, with production of commercial vehicles rivaling that of Japan and Canada. The main impediment to further growth for this group is a lack of scale -- in workforces and infrastructure -- to claim more than a portion of China's global market share.

Chaser Economies

Source: Bloomberg Economics

• Thailand benefits from a highly educated workforce and robust business environment. Vietnam and the Philippines have the advantage of low labor costs. Vietnam's high level of investment in education suggests potential to rise in the rankings.
• Malaysia's high labor costs are a barrier to export competitiveness. Strong infrastructure, business environment, and education are offsetting benefits. Those advantages -- on par with or even stronger than those of other members in the chaser group -- prompted us to move Malaysia up to the group despite its lower overall score.
• The main constraint for countries in the chaser group is limited scale. Limited export capacity and infrastructure and much smaller working-age populations mean they will aim to extend success in particular market segments rather than challenge China for the overall export crown.

Long-Shot Economies

Source: Bloomberg Economics

The long shots -- Bangladesh, Cambodia, Myanmar, and Sri Lanka -- are a diverse bunch, from a small island to one of the world's most populous nations. What they have in common is a low-cost advantage, offset by deep shortfalls in other aspects of export competitiveness. In varying configurations, that means weak infrastructure, a challenging business environment, volatile governance and growth, and relatively low levels of education.

A Narrower Path to Export Prosperity

The world today is different from when China took off in the early 1990s. Then, globalization was in the ascendant. Now protectionism is on the rise. As President Donald Trump's tariff threat against Vietnam makes clear, China isn't the only target. And there are other challenges for aspiring exporters: Automation is displacing low-cost labor, and global value chains have exacting standards. Getting a foothold in global markets is harder than it used to be.

China retains considerable advantages. As Apple Chief Executive Officer Tim Cook has said, a massive skilled workforce -- skilled not just at the dexterity required on the production line, but all the way up the ladder to software application development -- is tough to find elsewhere.

What's more, inland provinces have lower land and labor costs than Guangdong and other pricey coastal provinces, giving companies an option of moving "in" rather than "out." Network effects mean it's difficult for individual companies to be a first mover away from their China-based supply chain. The prospect of sales into China's massive domestic market is an additional reason to stay, even as costs rise.

Lots of Little Chinas?

Data are the beginning of the analysis, not the end. A comprehensive examination of export potential would also include an assessment of policies and plans -- which countries are moving in the right direction and which aren't.

That's beyond the scope of this paper. What's already clear, though, is that China won't be dislodged from its dominant position as the world's factory by a single contender anytime soon. India is the only country with the large scale and low cost to pose a realistic challenge. Getting there would require a significant improvement in infrastructure, as well as reforms to land and labor markets that have so far eluded the Modi government.

A more realistic prospect -- and something already under way -- is that different Asian economies gain a foothold in different market segments, then work to expand it. For the chasers group, the ambition must be to take a growing share of the electronics supply chain. For the long-shot countries such as Bangladesh, the beginning of the development process is textiles and toys.

Methodology

To build the index, we applied different normalization techniques for the data:

• For continuous variables, we used the min-max normalization approach to rescale the sample data to range from zero to 1.
• For measures that fell on an existing scale, we also used the min-max normalization approach, but used the top and bottom of that scale as the maximum and minimum values, respectively.
• For percentage variables, we divided these by 100 to rescale their values to run from zero to 1.

Next Exporter Index – Variables

Chang Shu is the Chief Asia Economist for Bloomberg Economics. She previously worked as senior economist at the Bank for International Settlements and Hong Kong Monetary Authority. Her publications span analysis of the yuan and cross border linkages in Asian financial markets.

Disclaimer: This article first appeared on Bloomberg.com, and is published by special syndication arrangement.