By Eric Vandenbroeck and co-workers

China Is Squeezing Southeast Asia

Southeast Asia should be benefiting from China’s rise. Beijing has made the region’s growth a priority: Chinese leader Xi Jinping’s Maritime Silk Road - the nautical pillar of the Belt and Road Initiative, China’s global infrastructure and investment program - put Southeast Asia at the heart of Beijing’s geoeconomic strategy and made it a prime target for development opportunities. Southeast Asia has attracted roughly $126 billion in Chinese investment in the last decade, and in 2020, the region surpassed the United States and the European Union to become China’s largest trading partner. As Washington revives tariff threats and global demand slows, Beijing has embraced more trade with countries in the Association of Southeast Asian Nations. In October, leaders signed the China-ASEAN Free Trade Agreement 3.0, an updated version of an accord last revised in 2015, deepening the region’s integration with China.

But what once seemed like a path to shared prosperity now feels like a dead end. China’s economic gravity is suffocating the very economies it has promised to lift. Trade deficits with Beijing have ballooned as local industries, from textile producers in Indonesia to steel makers in Thailand, struggle against a flood of underpriced Chinese goods. Economists often argue that Chinese investment and exports, which primarily include intermediate parts and components used to make other manufactured products, should be creating opportunities for Southeast Asia to grow. But the continued reliance of Chinese investors on supply chains back home means that regional economies are not benefiting from many of the productivity gains, industrial clusters, or technology transfers that often follow such foreign investments.

Part of the challenge is China’s growth model: in the face of falling profits, excessive competition, and meager domestic consumption, Chinese firms must expand to overseas markets to survive. But Southeast Asia’s political institutions play a role, too. Many countries in the region struggle with weak rule of law, entrenched patronage networks, and regulatory capture, in which businesses effectively co-opt the government agencies that are supposed to monitor them. Overseas investors play by local rules - and in Southeast Asia, the rules are too weak to hold them back from taking advantage of, or even worsening, the lack of effective oversight or transparency.

When China entered the global trading system in 2001, economists referred to the sudden impact on jobs and industries in the advanced industrial world as the “China shock.” Now, Southeast Asian countries, squeezed by a glut of Chinese exports, are grappling with a “second China shock.” As Chinese-backed mining projects, infrastructure, and special economic zones - particularly those rife with illicit activities such as gambling and scam syndicates - proliferate in Southeast Asia, local resistance and public unrest are surging. This discontent is not just a diplomatic irritant for China but also a test of one of the goals of its statecraft: to promote stability through economic integration. So far, business elites and governments in Southeast Asia have played nice with Beijing or colluded with Chinese investors. But if regional leaders are to avoid economic stagnation and the upheaval that it fuels, they must put the region in a position where it can benefit from China’s economic expansion, not suffer under its weight.

Assembling an electric vehicle at BYD's factory in Rayong, Thailand, July 2024

 

Flightless Geese

Economists and Chinese officials who are optimistic about Southeast Asia’s growth highlight the flying geese model of industrial upgrading that helped Hong Kong, Singapore, South Korea, and Taiwan develop in the wake of Japan’s early success. In the 1960s, as Japan industrialized and its labor costs rose, the country’s lower-income neighbors adopted its model and took over the industries it was leaving behind. Today, China is flying out front and ostensibly guiding Southeast Asia’s rise. It is moving toward more capital-intensive industries in addition to increasing investment in and trade with countries across the region. The flying geese model suggests that expanding Chinese capital should, in turn, benefit Southeast Asian countries and support the development of their own industries.

But the economic relationship between China and Southeast Asia is increasingly imbalanced. In 2025, China recorded a global trade surplus of more than $1 trillion, of which ASEAN countries accounted for roughly 23 percent. Their imports from China have surged since 2020, but their exports to China have largely flatlined over the same period, boosting the region’s trade deficit with Beijing from just over $10 billion in 2010 to roughly $140 billion in 2024. Goods from China are flowing to Southeast Asia, but the amount of value created by the region’s manufacturing sector has not kept pace with the expansion of trade. According to UN Trade and Development (UNCTAD) data, in 2023, Southeast Asia contributed only five percent of global value-added in manufacturing - about the same share as a decade earlier. China, by contrast, accounted for 28 percent, about ten percentage points higher than in 2012.

These widening gaps indicate that China - the leading goose - is moving toward higher-value manufacturing without uplifting Southeast Asian economies at the same rate. When Chinese companies invest in Southeast Asia, local economies are not benefiting in the ways that once allowed other countries to thrive under the flying geese model. At the upper end of the manufacturing value chain, in sectors such as electric vehicles, batteries, and solar panels, Chinese firms relocate only the most labor-intensive parts of the production process to Southeast Asia. Beijing encourages companies to keep the highest value-added processes in China and warns against letting core technologies or knowledge transfer to the country where the product is being manufactured. In Indonesia, for instance, Chinese companies control roughly 75 percent of nickel refining and are developing a $6 billion battery complex. Indonesia captures only about ten percent of the value added during the full production process, from mining ore to assembling battery components. The rest of the money flows back to the initial investors in China as profit and to repay loans.

Chinese companies also prefer not to use local suppliers in their Southeast Asian factories. Cutting-edge Chinese firms have built largely self-contained systems at home in which they control production at every stage from raw materials to final assembly. This prevents them from integrating with local manufacturers and sometimes even crowds the host country out of the industry. The opening of the electric carmaker BYD’s first overseas factory, in Thailand in 2024, brought a surge of imported intermediate goods from China, including high-end battery systems, motors, and basic structural components, to be assembled into automobiles at the new plant. But the influx of cheap steel auto parts caused a 20 percent drop in sales from existing Thai suppliers, which have traditionally provided such components to Japanese carmakers in Thailand. Chinese solar investments in Vietnam, too, function more as an export-processing hub than a manufacturing base, prompting critics to suggest that Southeast Asia is merely a byway for China to ship its goods elsewhere.

Beijing’s push for technological self-reliance is also undercutting Southeast Asian countries in advanced sectors in which the region is gaining ground, including semiconductors. Malaysia, Singapore, and Vietnam supply chips for autos, industrial equipment, and consumer electronics. But demand from China is likely to weaken as Beijing subsidizes domestic companies to wean themselves off imports. Within five years, China will likely be able to produce most of its own legacy chips, which rely on older technology but are still essential for the majority of products on the market. As Chinese firms substitute local components with Chinese chips in semiconductor production, another avenue for Southeast Asian development is constrained.

Meanwhile, China is not shedding the labor-intensive industries that might be expected to migrate to Southeast Asian countries with lower costs. Industries in Vietnam, for instance, face immense pressure from the millions of cheap orders - worth $2 billion monthly - that flow into the country every day from Chinese e-commerce platforms. Imports of cheap Chinese textiles and garments contributed to Indonesia shedding nearly 80,000 jobs in those sectors in 2024. Local producers cannot compete with the scale and efficiency of China’s world-leading industrial ecosystem. More than 2,000 economic development zones in China offer firms access to both upstream and downstream suppliers all in one place. A large renewable energy firm like Trina Solar, which assembles panels at an industrial park in eastern China’s Jiangsu Province, for example, can find tempered glass, aluminum frames, and other essential components within arm’s reach. Other Chinese firms have turned to robotics and factory automation to offset rising labor costs without moving production abroad. Midea Group, the home appliances giant, has invested billions to convert its facilities into highly automated “lights out” factories that can operate with as few as ten percent of the workers required previously. Government policy has reinforced this shift with national directives and heavy subsidies to promote industrial automation, particularly in the low-skill manufacturing sectors most vulnerable to offshoring.

 

 

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