This article first appeared in Forum, The Edge Malaysia Weekly on March 25, 2024 - March 31, 2024

Since the start of the US-China trade war in 2018, companies reliant on China's manufacturing surge have been actively exploring alternatives to diversify their supply chains. Southeast Asia has emerged as a prime destination for several compelling reasons. The region boasts a youthful workforce, varied industry specialisations, abundant raw materials and a strategic geographical position that facilitates efficient service to both Western and Eastern markets. Notably, media reports highlight that a substantial 60% of Samsung mobile phones are currently manufactured in Vietnam, while Apple has shifted a portion of its latest iPhone production to India.

The momentum behind the relocation of industries away from China is fuelled by a combination of factors. First, the persistent trade tensions between the US and China show no signs of abating, even amid the Covid-19 pandemic. These tensions have expanded beyond traditional trade realms to encompass high-tech, finance, geopolitics and other sectors. Many multinational firms are increasingly concerned about potential high sanction risks that the US might impose on their operations in China.

Secondly, the global supply chain disruptions and shortages experienced by advanced countries during the pandemic have prompted governments and companies to re-evaluate the security of their supply chains, especially those heavily reliant on China. Furthermore, China's de facto nationwide lockdowns in the latter half of 2023 have intensified the determination of multinational firms to diversify their supply chains rather than solely relying on China. This cautious approach was spurred by the recognition that concentrating all operations in China entails significant risks.

The pandemic also exacerbated the challenges within China’s business environment. In addition to strict human mobility restrictions, Chinese authorities implemented sweeping regulatory measures in 2021, affecting various sectors including real estate, private education, online gaming and financial technology (fintech). This regulatory crackdown has prompted international investors to question the viability of China as a conducive business environment.

The “China + 1” strategy involves companies diversifying their supply chains by establishing an additional manufacturing or production base outside of China. This strategic approach aims to reduce dependence on China as the sole manufacturing hub, thereby mitigating risks associated with trade tensions, supply shortages and regulatory changes within China.

To assess this, we compare Malaysia with its regional counterparts as potential investment destinations for diversification efforts. Among our regional peers actively seeking foreign direct investment (FDI) in the context of supply chain diversification are Indonesia, Thailand and India. According to the International Institute for Management Development World Competitiveness Ranking, Malaysia ranks 27th out of 64 countries. This ranking places Malaysia ahead of Indonesia, Thailand and India, suggesting a favourable environment for investment and business operations.

At a categorical level, Malaysia has the strongest economy and infrastructure among the four countries; however, it trails behind Thailand in government efficiency and records the lowest rank in business efficiency. Government and business efficiency are integral components of soft infrastructure that are crucial for fostering FDI and facilitating business formation. Our shortcomings in these aspects, attributed to regulatory inefficiencies, protectionist policies, brain drain challenges and a lack of local business adaptability to global trends, contribute to our diminished performance in these metrics. These challenges impede our capacity to capitalise on global trends and attract investments seeking destinations beyond China.

A closer examination of the shifts in rankings over the years provides intriguing insights. Despite notable advancements in all fundamental aspects in 2023, our standings in categories, apart from economic performance, demonstrate a decline compared to pre-Covid levels.

This prompts a critical evaluation of the factors influencing our rankings across diverse criteria. While our efforts have evidently improved our economic indicators, strategic reassessment and targeted interventions are needed to address the areas where our performance lags behind pre-pandemic benchmarks.

This raises the issue of our economic resilience. Our continual strong economic performance today is built upon solid economic foundations that emerge from three key factors.

First, our abundant natural resources have been a significant contributor to our economic prosperity. The oil and gas sector alone constitutes approximately 20% of Malaysia's gross domestic product  and serves as a primary source of government fiscal revenue. This industry has played a crucial role in supporting various aspects of the economy, funding both operational and developmental expenditure. While lucrative, this coffer is threatened by the escalating global concerns regarding climate change, posing the risk of rendering this sector obsolete and unprofitable in the future.

Secondly, during the past era of good governance, we have successfully established a substantial manufacturing hub, particularly focused on electronics. This strategic move has consistently driven economic growth and employment. The current economic prosperity is a testament to past policies that continuously fuelled our economic engine. Nonetheless, this momentum may wane if we fail to keep pace with evolving global trends.

Thirdly, the rise of Malaysia in the past decades happened in tandem with the lacklustre development of our neighbours. In the epoch of the country’s industrialisation, we were one of the most appealing countries in the region. Our strength lay in political and economic stability, coupled with a young and competitive workforce. However, this landscape is evolving. Vietnam, Indonesia, Thailand and the Philippines have emerged as formidable contenders, challenging Malaysia across various dimensions of economic vibrancy. These countries are offering liberalised trade regulations, young and adaptable workforces, streamlined business setups, accessible foreign visas and a notable absence of protectionist policies, among other factors.

Foremost, we need to acknowledge that our current strong economic performance is an outcome of our historical legacy. In the face of intensifying global competition, we cannot hinge our progress solely on past achievements.

Adapting to a shifting global landscape demands resilience, competitiveness and dynamism. To harness the advantages of supply chain diversification, we must construct a sturdy economic foundation that propels investment and fosters growth. The fundamental building blocks for achieving this are as follows.

1.     Enhance investment promotion to attract high-value firms: Elevate efforts to draw top-tier anchor companies to Malaysia, particularly in key sectors such as green technology, digital enterprises, agritech, semiconductor manufacturing and the halal industry. This effort will be complemented by tax incentives such as pioneer status, investment tax allowances and reinvestment schemes.

2.     Remove protectionist policies for foreign firms: Tesla’s exemption from the minimum 30% equity ownership by bumiputera should be expanded to include all foreign investments.

3.     Ensure governance and policy stability: Uphold consistency and predictability in trade policies to mitigate uncertainty for businesses, particularly during the period of political transition. A stable regulatory environment is crucial to attract foreign investment and nurture a robust trade ecosystem.

4.     Streamline regulatory processes: Simplify regulatory frameworks and expedite bureaucratic procedures to eliminate barriers that deter foreign investors. A complex regulatory environment or slow bureaucratic processes deter foreign investors who may find setting up business easier in other Southeast Asian nations.

5.     Enhance workforce education and training: Invest in upskilling and reskilling programmes to equip the local workforce with the skills needed for higher-value jobs. Addressing the current reliance on low to middle-skilled labour through broadened educational initiatives will contribute to national workforce development.

6.     Facilitate visa requirements: Implement easier visa processes, including long-term stay visas and foreign worker visas, to attract talent from abroad. Encouraging the influx of foreign workers to complement our existing market should be encouraged to address skill gaps, facilitate knowledge transfer and alleviate manpower shortages.

Malaysia’s strategic location in Southeast Asia and its well-developed infrastructure make it an attractive alternative for companies looking to diversify their supply chains. The country’s strong trade ties, especially within the Asean region, provide an excellent platform for companies to access other regional markets.

To capitalise on the potential of supply chain diversification, it is imperative for the country to enhance its economic foundations, aiming not only to match but surpass the benchmarks set by neighbouring countries. This strategic approach will enable Malaysia to assert itself as a prominent trade partner and sought-after investment destination, not only in the US and China but also across various regional markets.

Doris Liew is an economist, public policy thinker and environmentalist at Penang Institute who regularly observes Asean’s economic development, policy frameworks and regional and international trade dynamics

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